Size, Growth, Profits, and Executive Compensation in the Large Corporation: A Study of the 500 Largest United Kingdom and United States Industrial Corporations

By David J. Smyth; William J. Boyes | Go to book overview

6 Profitability, Size and
Concentration

I INTRODUCTION

In this chapter, we investigate the influence of firm size and industrial concentration on firm profitability.

In a perfectly competitive world, profit rates tend to equality. As imperfect markets are taken into account the size of a firm must be considered as a factor in producing profits. Baumol ( 1967) suggested that the larger firm may be in a position to earn a higher rate of return on its investment than the smaller firm because it has all the options of a smaller firm open to it and in addition can undertake projects that are of such large scale that they are denied to smaller firms. A similar argument had earlier been put forward by Steindl ( 1945). A counter-argument is that size breeds inefficiency and that, accordingly, large firms cannot undertake the options open to a small firm as efficiently as the small firm and hence profitability may decline with size of firms. Also Benishay ( 1961) has argued that the stock market will tend to favour large firms so that there will be a negative relationship between profitability and equity.

Thus we find that some theoretical arguments suggest that profitability should increase with firm size; others suggest a negative relationship.

Profitability may be expected to be directly related to the monopoly power of a firm. The proposition often stated is that the level of concentration affects the interdependence among firms and therefore the closeness of their market performance to the theoretical monopoly solution. A common way of measuring monopoly power is by the use of indices of concentration and we shall follow this procedure. The hypothesis generally investigated is that the firms in more highly concentrated industries are in a position to create higher profit rates than firms in less concentrated industries.

We shall not run separate regressions for individual industries or

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