Employment growth and profitability in European SMEs: the 100% speed limit

Abstract

ABSTRACT We investigated the relationship between employment growth and profitability and propose that small and medium-sized enterprises (SMEs) hire employees, they experience an increase in profitability due to their acquisition of additional human capital. These benefits, however, are limited by the firm’s ability to efficiently integrate the newly recruited employees and adjust its internal managerial practices and organization accordingly. Using a large sample of SMEs in the European Union, we examined the relationship between employment growth and profitability as a quadratic function with an inverted U shape. The empirical results strongly supported our prediction as we observed that profitability decreased when SMEs exceeded a 100% growth rate in employment. Importantly, we observed strong homogeneity in our results across various industries. This paper empirically documents the ‘maximum’ speed at which firms should grow and highlights the homogeneity of this result across industries.