Size, size potential, and expected stock returns

• Published date: 01 October 2021
• Author: Roi D. Taussig*
• Date: 01 October 2021
• DOI: http://doi.org/10.1002/jcaf.22516

Received: 28 June 2 021Revised: 8 August 2021Accepted: 10 August2021

DOI: 10.1002/jcaf.22516

RESEARCH ARTICLE

Size, size potential, and expected stock returns

In memory of Simon Benninga

Roi D. Taussig*

Ariel University, Department of

Economics and Business Administration,

Ariel, Israel

Correspondence

RoiD. Taussig, Ariel University,Depart-

mentof Economics and Business Adminis-

tration,Ariel 40700, Israel.

Email:roit@ariel.ac.il

Abstract

The financial literature shows that, on average, larger firms earn lower returns.

This study examines the relationship between market capitalization and stock

returns, as well as the size growth potential of firms according to their economies of

scale (size and size potential are not correlated). According to generally accepted

beliefs, larger firms do earn lower returns on average. This study adds to the

literature by finding that firms’ size potential (according to their economies of

scale) is also negatively related to firms’ average returns. This new information

is significant–both statistically and economically.

KEYWORDS

asset pricing, economies of scale, market capitalization, size, stock return

1 INTRODUCTION

The Capital Asset Pricing Model (CAPM; Black (1972);

Lintner (1965); Sharpe (1964)) expresses the expected

return on an asset by employing the coefficient of system-

atic risk beta and the securities market line (SML). Some

anomalies to the CAPM have been researched over the

years. For instance, Broadstock and Zhang’s (2019) study

shows that the social media of sentiment factors can also

explain stock returns. Taussig and Klein (2021) show that

higher firms’ renting expenses (relative to assets owned)

relate to higher risk and higher expected stock returns

(Taussig & Klein, 2021).

According to the financial literature of the past decades,

on average, larger firms earn lower returns than smaller

firms. This phenomenon is known as the size effect (Banz,

1981). We add to the existing literature by analyzing not

only size (market capitalization), but also the size potential

of firms according to their economies of scale (hereinafter

EOS). According to the analysis, size and size potential are

uncorrelated in the sample. In addition, size and size poten-

tial are negatively connected to stock returns. This effect is

noteworthy–both statistically and economically.

Section 2describes the literature review, Section 3dis-

cusses the methodology and data, Section 4presents the

results, and Section 5concludes.

2LITERATURE REVIEW

The negative relationship between size and stock returns

has been examined in many studies (Astakhov et al., 2019).

During certain subperiods, it is not significant, but over-

all, there is a premium of 1.72% between the smallest and

largest quintiles of the NYSE (Astakhov et al., 2019). While

some studies assert that the size effect disappeared in the

early 1980s, a recent study confirms that when account-

ing for profitability shocks, the size effect is present and

accounted for (Hou & Van Dijk, 2019). However, it should

be noted that the size effect is predominantly present in Jan-

uary (Keim, 1983).

Economies of scale has been documented already in 1963

(Walters, 1963). EOS was found in many industries. For

example, EOS was found in mutual fund administration

(Latzko, 1999). Lambrecht examines the timing and terms

of mergers where there is EOS (Lambrecht, 2004). Con-

trolling for size shows economies of scale in reducing the

J Corp Account Finance. 2021;32:27–30. © 2021 Wiley Periodicals LLC27wileyonlinelibrary.com/journal/jcaf