Profitability and size of newly established firms

Abstract

Does size matter for new firms and do they need to be large to be profitable? From small to large firms, a wide range of arguments have explored the possible strengths and liabilities associated with size. Despite the long interest in the relation between size and profitability, the empirical evidence is mixed and inconclusive. To date, studies focus mainly on established firms. In order to advance the knowledge on the relation, we examine the effects of size on the profitability of newly established firms in their first years of business. Overall, the results show that size has a positive impact on the profitability of new firms. In particular, increases in the number of employees have a positive effect on the return on assets that indicates that being small is a liability for new firms. Further, this finding indicates the need for a certain critical mass of employees when firms start out. By starting out with a higher number of employees, new firms may invest in the development of their performance by stimulating learning and motivation and, in this way, increase their profitability and their chances of survival. In addition to the liability of smallness, we also investigate the moderator effect of age. Our conclusions support the liabilities of obsolescence and senescence arguments that state that as firms age, they have difficulties in adapting to the external environment and face internal inertia.