Structure and Behavior of Multi-product Firms: Evidence from India

A central theme of international trade research has been the impact of trade liberalization on productivity. Early literature on this theme points out that trade liberalization brings resource/organizational adjustment across industries and this adjustment enhances productivity. A traditional comparative advantage or monopolistic competition model examines responses at the average, i.e. homogeneous firms. In recent years, heterogeneous firm models with a general equilibrium framework expand the debate to include organizational adjustment across firms. The productivity improvement in the heterogeneous-firms framework arises through organizational adjustments of industries or firms following trade liberalization. The exit of less efficient industries or firms and the transfer of their resources to more efficient industries or firms lead to improvements in industry or national productivity. A new strand of the heterogeneous firm literature is now considering explanations of productivity change arising from intra-firm resource reallocation in the presence of product heterogeneity. Under firm heterogeneity, a firm’s technology uses determine their productivity; technology usages include technologies adoption and efficient use of adopted technologies. However, recent literature points out that there is a possibility that intra-firm resource reallocation affect a firm’s productivity in addition to technology usages. The purpose of this study is to show whether intra-firm resource reallocation affects multi-product firms’ TFP. Intra-firm resource reallocation is made up of two components: the number of products a firm produces (product range), and the way a firm allocates input resource across products (skewness of production). For this study, TFP is measured using De Loecker’s (2011) approach adopting the Cobb-Douglas production and CES utility functions under multi-product firms and applying two-stage estimation procedure. The intra-firm resource reallocation and productivity link is examined through the testing of two hypotheses: (i) high productivity firms have larger revenue and larger product range than low productivity firms and (ii) discontinuing a product and (/or) skewing production toward a particular product increases TFP while adding a product and (/or) equalizing the production of all products decreases TFP. These hypotheses have three implications. First, TFP is positively correlated with both revenue and product range. However expanding product range decreases TFP due to increasing possibility of input resource misallocation. Second, a firm’s TFP depends not only on technology usages, but also on intra-firm resource reallocation. The product range and he way to allocate input resource across heterogeneous products also affect a firm’s TFP. In other words, aggregate TFP depends not only on organizational adjustment across industries or firms, but also on organizational adjustment within a firm. Finally, getting export status significantly increases multi-product firms’ productivity due to the relationship between intra-firm resource reallocation and productivity. For the empirical analysis, the production and finance accounts of the PROWESS database on Indian firms (31,100 firms with 213,134 observations; 3,844 products with 213,134 observations) are used. This unique database allows the study to focus on multi-product firms’ structure, productivity, product range, and skewness of production.