Firm size and productivity differential: theory and evidence from a panel of US firms

The US industrial sector displays heterogeneity among firms on the basis of their size: smaller firms exhibit a higher profit rate, lower survival probability and difficulty in accessing the capital market. A simple theoretical model that generates these features based on private information regarding managerial actions at firm-level production is developed and tested. Using a large panel of publicly traded US firms, parameters of the production technology for large and small firms are estimated for the 1970-1989 period. The empirical results indicate that small firms are significantly more productive but also more risky than their large counterparts. The estimation results imply that the notion of a tradeoff between flexibility and efficiency be adjusted for the dimension of risk. Small firms facing market uncertainties, capital constraints and other challenges undertake actions that make them more efficient than large firms but is achieved at the cost of increasing their riskiness. (C) 2001 Elsevier Science B.V. All rights reserved. JEL classification: D24; D82; L11.