Why Europe Doesn’t Have Trillion Dollar Companies

With a hat tip to Tyler Cowen I want to take note of this post by Pieter Garicano:

These answers, according to a recent paper by Olivier Coste and Yann Coatanlem, two French entrepreneurs, miss the point: the reason more capital doesn’t flow towards high-leverage ideas in Europe is because the price of failure is too high.

Coste estimates that, for a large enterprise, doing a significant restructuring in the US costs a company roughly two to four months of pay per worker. In France, that cost averages around 24 months of pay. In Germany, 30 months. In total, Coste and Coatanlem estimate restructuring costs are approximately ten times greater in Western Europe than in the United States.1

These costs kick in when a major venture has failed; it follows that the higher the probability of failure in a sector, the greater the relative disadvantage for Europe. The lack of repeat founders and ‘audacious’ venture capital are symptoms of this underlying malady.

Consider a simple example. Two large companies are considering whether to pursue a high risk innovation. The probability of success is estimated at one in five. Upon success they obtain profits of $100 million, and the investment costs $15 million.

One of the companies is in California, where if the innovation fails the restructuring costs $1 million. The other company is in Germany, where restructuring is 10x more expensive, it costs $10 million (a conservative estimate)

The expected value of this investment in California is a profit of $4.2 million. In Germany the expected value is a loss of $3 million.

I first became aware of this almost fifty years ago when I was a manager for a large German company. They liked hiring Americans at the time due to the flexibility it provided.

While Mr. Garicano’s observations are about capital investment I think the more pertinent issue has to do with mergers and acquisitions, so many of which involve not just capital but reorganizations. The key point is that reorganization is so costly in Europe companies are disincentivized from doing it.

The dynamism obviously has benefits but it has costs too and IMO our present approach worked well when we were creating new jobs rapidly but it’s much less acceptable now. I’ve said this before but I’ll say it again. I think that large companies should be if not outright prevented at least disincentivized from acquiring small, innovative companies. I don’t think that doing something and then being acquired by Microsoft, Meta, or ABC should be a viable business model. There are too many cases in which these vast conglomerates acquired competitors to mine their technology and then put them out of business.