Firm Size and Profitability

A BASIC proposition of economic theory is that, under competition, profit rates will tend toward equality. Baumol, on the other hand, has put forward the hypothesis that increased money will not only increase the total profits of the firm, but because it puts the firm in a higher echelon of imperfectly competing groups, it may very well also increase its earnings per dollar of investment 5, p. 33. The logic of Baumol's proposition is that large firms have all of the options of small firms, and, in addition, they can invest in lines requiring such scale that small firms are excluded. It follows that . . so long as any industries are peculiarly well suited to large investments, and so yield disproportionate returns to sizeable funds, then, provided is prepared to move in response to profit differences, this will tend to be true of all other industries in which large firms operate 5, p. 37. If this hypothesis is correct, we should find higher rates of return in large enterprises even in the long run and even in the absence of barriers to entry other than those directly associated with availability of capital. An empirical test of this proposition should give a basis for judging the height of the capital requirements barrier 2, p. 156, a potentially important element in the explanation of industry performance. The primary goal of this paper is to test Baumol's hypothesis. It is divided into three parts. In section I we discuss our data and our model, in section II we present and analyze our results, and in section III we draw a few tentative conclusions. I