Larger listed companies barely outperform smaller ones now, a new study argues

BVWire–UKIssue #7-2
October 14, 2019

cost of capital
cost of capital, discount rate, private company valuation, risk analysis, cost of equity, size effect

Published research has overstated the size premium, says ‘Firm Size and Stock Returns: A Quantitative Survey,’ a new analysis conducted by Anton Astakhov, Tomas Havranek, and Jiri Novak from the Institute of Economic Studies at Charles University in Prague. The article appears in the Journal of Economic Surveys.

Astakhov, Havranek, and Novak collected estimates of the effect of size on stock returns reported in 102 published studies and synthesised the often-conflicting results. Their ‘meta-analysis’ concludes that published research initially showed a significant size premium but that the bias declined as newer research had different findings. Specifically, the study found a drop of about 50% in the magnitude of the size premium in studies using data after 1981 compared to studies with earlier data. That year is considered a turning point after Rolf Banz identified the small stock premium, and many analysts believe that the new research led many investors to adjust their portfolios, thereby diminishing the differences in experienced market returns Banz had identified.

‘Our findings support the proposition that the magnitude of the size premium varies over time (Horowitz et al., 2000a; van Dijk, 2011) and more specifically that it has decreased after [the] 1980s,’ the researchers conclude.

BVWire—UK notes that other studies suggest price multiples of smaller private firms are lower than multiples of larger private firms, which may be evidence that a size premium still exists in private firms. Often, illiquidity and inefficient markets for private firms, rather than size, are the real reason that a small enterprise may be worth less than a larger one. This new study agrees that size may still affect private-company returns, but the authors say their meta-analysis restricted most of the extra risk to the very smallest segments of the private markets.

Further, using public market data as a proxy for estimating private-company risk and performance will always be problematic. The researchers note a strange anomaly, for instance, that the size premiums remain large since the 1980s—if you only consider returns data from the month of January for each year (no one appears to understand the bases for this statistical pattern).

And most of the past studies included here, many conducted by some of the leading scholars of finance theory, focus on North American market data. Past studies that include LSE or other European returns information continue to show slightly larger size premia than returns for companies listed on NYSE or Nasdaq.

Even more confounding is this finding from the new meta-study:

[T]he size premium is positive when there is a general tendency of stock prices to decrease (i.e. in the ‘down markets’ or the ‘bear markets’), whereas it is close to zero when the stock prices have a tendency to rise (i.e. in the ‘up markets’ or the ‘bull markets’; Hur et al. 2014). This seems to be contrary to the notion of systematic risk, which predicts low returns on riskier assets in times of economic downturn when scarcity of income increases.

The debate within the business valuation profession (and the audit community) regarding the size premium in stock returns has raged for years, with no consensus over its magnitude or stability—or even existence. Yet, this first meta-analysis of the size premium provides an estimate that is smaller than what many people believe. 

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