Profitability Performance And Firm Size-Growth Relationship

Abstract

In this study, we intend to examine empirically how a firm’s profitability performance would impact its growth process and what implications follow for the validity of Gibrat’s law. The basic thesis that is tested in this study is that smaller firms, being more constrained in obtaining outside funds for growth, can possibly show a higher propensity to growth when their internally generated profits are high. To this end, we apply a dynamic model to panel data on a sample of firms in the USA. We first investigate the size-growth relationship for the whole sample, and then, these firms are classified into three profitability performance groups on the basis of the average size of profits as percentage of stock-holders’ equity. The empirical results emanating from this study are mixed, with the dominant result that in many cases, larger firms grow faster, violating Gibrat’s law. Moreover, the results do not lend visible support to the hypothesis that higher profitability confers a growth advantage to the smaller firms.