Abstract: Establishments that start operating during recessions employ fewer workers at entry and over time, although these establishments are, on average, more productive. Moreover, the entry rate is procyclical and four times as volatile as aggregate employment. Standard firm-dynamics models are not able to account for these facts without generating excessive volatility in aggregate variables. I show that potential entrants’ ability to delay entry that leads to the countercyclical opportunity cost of entry accounts for the observed significant effect of the initial economic conditions on the selection of entrants. I propose a model that reconciles the documented life cycle dynamics of U.S. establishments on average, and over the business cycles. I find that the observed variation in the number and composition of firms at entry is responsible for more than three-fourth of the business-cycle fluctuations in aggregate employment. To validate these findings, I show that the model accounts quite closely for the recent cohorts’ contribution to the persistent drop in aggregate employment observed after the Great Recession. Finally, I show that not accounting for the option to delay entry may lead to misleading predictions about the response of potential entrants to different shocks or policies.

Keywords:   Option value of delay, entry, firm-dynamics, business cycles, Great Recession