Does the Firm Size Matter? An Empirical Enquiry into the Performance of Indian Manufacturing Firms

Abstract

The Law of Proportionate Effect depicts that firm's growth rate is independent of its size; Gibrat (1931). Some of the existing studies support the law: Hymer and Pashigian (1962), Mansfield (1962), among others. However, Gale (1972), Shepherd (1972) and recently Punnose (2008) report a positive relationship; while Haines (1970) and Evans (1987), among others observe an inverse relationship between the two. Baumol (1959) opines that rate of return increases with firm size. Therefore, the extant empirical research on the firm size - performance relationship provides inconclusive results.

Manufacturing firms' data from the Steel and Electrical & Electronics (EE) industries are taken from CMIE Prowess database for the period 2004-05 to 2006-07. Results show that firm size affects current profitability: positively in the Steel and negatively in the other. Some more determinants of firm performance are explored. Retained earnings have negative impact on profitability in Steel but, positive in the other. Bank credit is found negatively significant in both the industries. Interestingly, the impact of size is affected by firms' market value (Q): size positively affects profitability both in Steel and EE. The short-run dynamism in firm performance is also impacted by presence of Tobin's Q. Market share of firms and industry concentration ratio although inconsistently are the other significant determinants of firms' performance.

Keywords: Gibrat's law, firm size, profitability, Tobin's Q, manufacturing firms

JEL Classification: L6, L25, M21