How long must a firm be great to rule out chance? Benchmarking sustained superior performance without being fooled by randomness

Abstract

Although sustained superior firm performance may arise from skillful management or other valuable, rare, and inimitable resources, it can also result from randomness. Studying U.S. companies from 1965-2008, we benchmark how long a firm must perform at a high level to be confident that it is something other than the outcome of a time-homogeneous stationary Markov chain defined on the state space of percentiles. We find (a) the number of sustained superior performers in Compustat, measured by ROA and Tobin's q, exceeds the number of false positives we would expect to be generated by such a process; yet (b) the occurrence of false positives is often enough to fool many observers, so (c) the identification of sustained superior performers requires particularly stringent benchmarks to enable valid study.

Good Night, and Good Luck: Perspectives on Luck in Management Scholarship

“…As Barney (1997: 17) writes: what prescriptive advice can we give to managers given that the role of luck is important, 'that they should "be lucky"?' For others, luck is essential for explaining performance differences because randomness in structured environments can produce systematic patterns (Denrell, 2004;Denrell et al, 2015;Henderson, Raynor, & Ahmed, 2012;Levinthal, 1991). Still others argue that while good and bad luck can happen to anyone, some are more prepared than others (de Rond, 2014;Dew, 2009), for example, by being mindful enough to rebound from bad luck (Weick & Sutcliffe, 2006), or by securing a higher 'return on luck' (Collins & Hansen, 2011).…”

Predicting new venture survival and growth: Does the fog lift?

“…Random processes produce results that closely match the outcomes of many top performing companies, to the extent that investigating whether or not performance is purely random remains a valid research question (Henderson et al 2012;Denrell et al 2015;Storey 2011). This need not imply that managers do not put thoughtful planning and effort into their business decisions, because it could be that competition is so fierce, and businesses are all more or less 'neck-andneck', that there may not be any easily observed systematic factors that allow new ventures to enjoy prolonged above-average performance in the years after entry.…”

“…'Chance models are, in fact, compatible with effortful managers who carry out deliberate actions' (Denrell et al 2015, p. 936). Our preference for chance models in this paper is because random walk models offer useful approximations to real-world phenomena (Levinthal 1991;Henderson et al 2012;Denrell et al 2015), and also because random walk models can provide simple and clear theoretical predictions that can be developed into testable hypotheses. Levinthal (1991) was amongst the first to formally explore how random processes could shed light on venture survival in a managerial context.…”

Entrepreneurship and the determinants of firm survival within regions: human capital, growth motivation and locational conditions

“…However, a counter argument to this thesis is provided by Delmar, McKelvie, and Wennberg (2013) who find a negative relationship between growth in one period and survival in the next in the case of knowledge intensive start-ups, which they suggest may relate to growth itself being a risky activity. A stream of literature has modelled the growth of ventures as following a random walk due to competition from rivals, making it difficult to identify factors leading to better performance, particularly for new ventures with little previous history (Gibrat 1931;Levinthal 1991;Henderson, Raynor, and Ahmed 2012). This would mean that although growth may increase the chances of survival, it is extremely difficult to identify which firms will grow, with only a small proportion of variance captured by models (Coad et al, 2016), and therefore making it just as difficult to identify firms that are more likely to survive.…”