Why do some large firms seem almost immune to competition, remaining dominant not just for decades but across centuries? While innovation and entrepreneurship are often heralded as engines of economic progress, a crucial question remains underexplored: why do new firms so rarely succeed in replacing the old guard?
In “Impediments to the Schumpeterian Process in the Replacement of Large Firms,” forthcoming in the Journal of Finance, Daniels School professors Mara Faccio, the Tom and Patty Hefner Chair in Finance, and John McConnell, Burton D. Morgan Chair of Private Enterprise Emeritus, investigate a less-explored but critical component of Joseph Schumpeter’s theory of creative destruction. While extensive research links innovation and new firm creation to economic growth, the replacement — or lack thereof — of dominant incumbent firms has received comparatively little attention. Building on research that limits firm turnover to slower economic growth, the study investigates why large firms often remain dominant and identifies the barriers that hinder their replacement.
A range of historical and theoretical perspectives frame this inquiry. Schumpeter himself revised his thinking over time: his early work emphasized the disruptive force of new firms, while his later views acknowledged that incumbent firms might sustain their dominance through internal innovation funded by vast capital reserves. Schumpeter’s contemporaries offered more critical views, attributing corporate persistence to anti-competitive behaviors, such as restricting rivals’ access to finance or manipulating political processes to erect barriers to entry.
“Politically connected firms are significantly less likely to remain among the largest when markets are open to international competition. In contrast, reduced trade and capital openness greatly increases the likelihood that politically connected firms retain their dominant position.”
To answer their question, Faccio and McConnell constructed a large dataset spanning over 100 years and up to 75 countries. It includes archival records of the 20 largest firms circa 1910 in each of 60 modern-day nations, 50 years of data (from 1921 to 1971) on privately held and publicly traded Italian companies, and contemporary data from the 2000s. The study explores whether firms that were among the 20 largest in their country at the start of each period remained so decades, or even a century, later, and under what conditions.
A central finding is that political connections, defined as instances in which a director or an officer of a firm is a member of the government or parliament of its country, significantly increase the likelihood that the firm will maintain its dominant status over long periods. These connections matter more than firm quality indicators like innovation output, productivity, or profitability. Even after controlling for these variables, politically connected firms are consistently more likely to remain among the largest in their countries. Importantly, the study shows that these firms generally do not outperform others in financial or operational terms, casting doubt on the notion that they remain large due to being the best.
Faccio and McConnell also investigate the interaction between political connections and regulatory environments. They show that the ability of politically connected firms to maintain dominance is contingent upon the presence of barriers to both trade and capital flows. Politically connected firms are significantly less likely to remain among the largest when markets are open to international competition. In contrast, reduced trade and capital openness greatly increases the likelihood that politically connected firms retain their dominant position.
Robustness checks, including case studies, alternative firm size metrics, and controls for mergers and group affiliation, support these conclusions. Italy, for example, serves as a compelling case study due to the abrupt and legally mandated severing of corporate political ties following the fall of fascism in 1943-44. Drawing on historical firm-level data, the study investigates whether this exogenous loss of political connections affected the long-term standing of previously politically connected firms. It finds that these firms became significantly less likely to remain among the country’s 20 largest, even after controlling for firm-specific characteristics.
The broader implication of the findings is stark: political entrenchment, bolstered by regulatory barriers, inhibits the natural economic evolution expected in a competitive market. It impedes the Schumpeterian process, stifles firm turnover, and thereby hinders long-term economic growth. By contrast, in more open economies, market forces are better able to displace outdated incumbents, fostering a healthier economic dynamism.
This study adds substantial weight to concerns that the resilience of large firms is often not a product of economic efficiency but of political entrenchment. It challenges the assumption that market dominance is necessarily earned through superior performance and shows that regulatory environments heavily influence economic vitality. Importantly, the results show that over an extended period and unhindered by government intervention, the Schumpeterian process of economic evolution is likely to thrive, bringing with it the added benefit of enhanced economic growth.
