Contemporary Theory of Firm Growth Extended Version

The main aim of this paper is to explain why large companies maximized their sales after World War II. I derive a model of firm growth from the degree of operating leverage formula. Three versions of this model show consistency between profit maximization and sales revenue maximization and imply that higher and higher sales revenue growth rates are needed in subsequent periods to reach the initial growth rate of profit. Because of this dependence in subsequent periods, it is increasingly difficult for firms to achieve the necessary growth rate of sales revenue. I also perform a sensitivity analysis on the decline in initial sales revenue, unit variable costs, and total fixed costs. I find that companies’ situation in terms of profit maximization is deteriorating, as in subsequent periods ever-higher sales growth rates are necessary compared with the previous initial conditions. As a result, the company encounters demand or production capacity binding constraints, and the response of managers is to seek and apply new methods to increase the sales and market share domestically and internationally and not only to invest annually total depreciation but also to carry out large net investments to attain the necessary sales revenue growth rate. The model also supplies the microeconomic foundation for macroeconomics. In particular, it provides an explanation for the momentum and reversal phenomena.