Get the Balance Right: A Simultaneous Equation Model to Analyze Growth, Profitability, and Safety
52 Pages Posted: 29 Nov 2017 Last revised: 13 Apr 2018
Date Written: October 28, 2017
Extant literature suggests that the relationships among growth, profitability, and safety are reciprocal. Consequently, we develop a simultaneous equation model to test the three relationship pairs. Analyzing eleven years of data for 1,988 European insurance companies, we find that moderate firm growth has a positive impact on profitability; however, extremely high growth reduces profitability. Moderate firm growth also reduces firm risk. In addition, we document that less profitable companies are risk-seeking, a result in line with prospect theory. The longitudinal analysis illustrates that firms initially prioritizing profitability over growth are more likely to reach the ideal state of “profitable growth”.
Keywords: firm performance, simultaneous equation model, goal conflicts, financial services, insurance
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