FIRM EXIT, VINTAGE EFFECT AND THE BUSINESS CYCLE IN NORWAY Kjell G. Salvanes* Ragnar Tveterås** First draft: June 20 1997 This version: December 20, 1998 Abstract: In spite of the large and growing literature on producer heterogeneity and firm exit behavior, little attention has been paid to the vintage capital theory of firm exits as an alternative hypothesis to learning/selection. Interpreted at the firm level the vintage capital theory predicts that exit rates increase in the age of capital. The present paper uses a panel of Norwegian manufacturing plants and constructs an index of capital age in addition to the age of the establishment in order to disentangle the effects of selection/learning and vintage capital on exit rates. The empirical results suggest a U-shaped exit function in the age of the plant implying both a learning effect and a vintage capital effect. The vintage capital effect is present under different assumption concerning reinvestments and controlling for unobserved heterogeneity. The exit rates are found to depend on the business cycle in that exits increase in a severe downturn. Our results also support the assertion that recessions are periods of cleansing where old capital equipment is scrapped via exiting plants. JEL Classification: D24, L11, O33. Keywords: Firm exit, vintage effect, business cycle, manufacturing. Acknowledgement: We have benefited from comments by Tor Jakob Klette, participants at the EARIE meeting in Copenhagen 1998, and semianr participants at The Norwegian School of Economics and Business Administration. * Department of Economics, Norwegian School of Economics and Business Administration Helleveien 30, N-5035 Bergen-Sandviken, Norway kjell.salvanes@nhh.no ** Stavanger College, Department of Business Administration P.O. Box 2557 Ullandhaug, N-4004 Stavanger, Norway