Life and Death of Businesses: A Review of Research on Firm Mortality
Neither the literature of finance nor the literature of valuation practitioners has taken account of the relatively short life expectancy of firms. Fewer than fifty percent of new firms live longer than ten years; yet, it is common practice to estimate firm value with a very long term horizon model such as the constant growth model. The purpose of this paper is to increase awareness of the life expectancy of firms and show how to take account of the likelihood of firm death in valuation. Data on firm death rates and life expectancy that is available in the field of industrial organization is reviewed and summarized so that valuation practitioners can take it into account in their valuations.
Firm mortality in public companies and Natal Financial Care
How long do businesses live? -> Two common forms of business—sole proprietorship and partnership—die with their owners, but the limited liability corporation, which is a separate legal entity, can outlive its founders. However, as the existing literature concludes, the life expectancy of even these firms is brutishly short (Morris 2009).
According to a study of the involuntary “deaths”—liquidation, delisting and permanent trading halts—of U.S. publicly traded companies between 1985 and 2006, public companies die at an astoundingly rising rate in their first few years, and the third year is the most perilous.
<- We use econometric methodology from actuarial science to construct the first mortality table for U.S. public firms during 1985-2006. The table reveals that the age-specific mortality rates of firms initially increase, peaking at age three (3 times higher than the long-term mortality rate), and then decrease in age, implying that the first three years after a firm goes public are critical to its longterm survival.
<- In contrast to the stylized fact noted in the empirical industrial organization literature that survival risk decreases as a firm ages (literature starts with Audretsch (1991), Agarwal and Gort (2002) show that the effects of industry (exogenous shocks) and firm characteristics (endogenous response) both affect a firm’s survival. Loderer, Neusser, and Waelchli (2009) find that firm age impairs institutional memory and affects its survival.) our results indicate that U.S. public firms have to survive up to three years after the IPO—the critical age—before their survival risk can diminish.
<- After controlling for the usual determinants of survival (e.g., leverage, size, age, and growth opportunities), we find that financial intermediaries involved around the public birth of a firm—venture capitalists (VCs) and highquality underwriters—are associated with significantly lower firm mortality rates. (Though their beneficial effect is stronger during the first three critical years of a firm’s public life, the effect lasts sometimes up to seven years after the IPO. )
i) To identify the date of birth of a public firm, we follow Queen and Roll (1987) and use the date of a firm’s first appearance on the CRSP tape during the period of 1926– 2006.
ii) Death is even more difficult to define for public firms. A firm may have a voluntary death—going private or being acquired or merged—or it may have an involuntary death— getting liquidated or delisted by the exchange. Our study on mortality focuses on involuntary deaths, since the literature has documented the severe economic and social welfare consequences associated with them.
(Is all M&A really voluntary? At least some firms go to M&A under situations that similar to involuntary death.)
All mortality tables show the conditional probability that a cohort of a certain age will die before its next birthday. This probability is computed by scaling the number of deaths during a period by the number of members of the cohort existing at the beginning of the period. A mortality table is, therefore, a collection of age-specific mortality rates (ASMRs). 
<<– To build a meaningful mortality table without substantial gaps, we need a sufficient number of deaths of firms of various ages. Therefore, for firms appearing in the CRSP tape between 1926 and 2006, we calculate ASMRs during the period 1985–2006.
Figure 1 presents a graphical comparison of the ASMRs of U.S. public firms and those of U.S. residents. For each panel, the horizontal axis shows the different age groups. The vertical axis in Panel A shows the number of involuntary deaths of firms of a given age expressed as a proportion of all existing firms of that age. The vertical axis in Panel B shows the number of deaths of U.S. residents of a given age expressed as a proportion of all living U.S. residents of that age.
The graph of ASMRs attains a global peak of more than 6% when firms reach the third year after their IPO. ASMRs for firms that manage to stay in the public domain beyond 20 years comprise less than 2%.
* The authors did not include such “deaths” by a merger or acquisition in their analysis.
“Even though the acquired company might cease operations as an independent entity, its business might remain largely intact,” “Many of the relevant parties, such as shareholders and creditors, for instance, might also fare well in such events.”
(Remember, unlike Borisov’s study, which only counted “bad” deaths, the Sante Fe researchers included the vast majority of companies that disappear through mergers and acquisitions. They found similarly dire death rates—50 percent of all companies expired in the first decade—but they found no jumps in the mortality rate for young companies or at any age, regardless of cause of death or industry.
“The mortality risk was effectively constant across a firm’s lifespan.” “On average, it doesn’t matter if you sell bananas or airplanes, if you’re big or small, you’re facing a constant mortality risk.”)
Private firms mortality
A similar pattern of company mortality showed up in a CNBC analysis of data from the Bureau of Labor Statistics, which tracks private sector establishments. In that data set, a company opening up a new branch would count as a new establishment, even if it is part of a larger firm.
Unlike public companies, which are presumably already fairly successful by the time they file for an IPO and probably have a cushion of backing to get them through the early years, the privately owned companies that make up most of the private sector are more likely to fail in their first few years.
Only about 1 in 5 establishments survive for 20 years or more
Papers in finance that studied firm mortality
On the other hand, there is a large indirect literature in finance on firm mortality studying the determinants of debt default. The seminal work of Altman (1968) popularized the Z-score, which is a summary statistic of relevant accounting variables that purport to capture the probability of default.
For each calendar year between 1985 and 2006, we count the number of involuntary deaths of firms between age x and age x + 1 during that year and divide this number by the number of existing firms of age x at the beginning of the calendar year. This ratio is the ASMR for the age x cohort during this calendar year. To illustrate, consider the ASMR for firms of age five in year 2000. We count the number of involuntary deaths of firms between ages five and six in calendar year 2000 and divide this number by all five-year-old firms existing at the beginning of year 2000 (i.e., firms that went public in 1995 and survived until the beginning of year 2000). We then calculate the ASMRs for firms aged zero to 80 in year 2000, respectively.
We repeat this process for every year in the period 1985–2006 by constructing ASMRs for firms aged zero to 80 in that year. For each age, zero to 80, we average its ASMRs across all the years between 1985 and 2006. We then apply the average ASMRs to a hypothetical cohort of 100,000 firms. This gives us the number of firms that die at age zero, one, and so forth. To focus only on the first few years, we tabulate the deaths of the members of this hypothetical cohort at the ages of zero, one, two, three, four, five to nine, 10–14, 15–19, 20–24, 25–29, 30–34, 35–39, 40–44, 45–49, 50–54, 55–59, 60–64, 65–69, 70–74, and 75–80. The ASMRs for ages zero, one, two, three, and four are already computed. To estimate the ASMRs for the five-year age bins after that, we count the number of involuntary deaths during a given five-year age interval and divide this number by the number of firms existing at the beginning of that interval. To annualize the ratio, we multiply it by one-fifth.