You can’t be too thin…but you can have too large a size premium

BVWireIssue #98-3
November 17, 2010

Mike Crain is doing some interesting research on the size premium...or lack thereof.  He presented his research last week at the AICPA National Business Valuation Conference, and an analysis of his conclusions will appear in the December Business Valuation Update.

One conclusion he's drawing is that the size premium has all but disappeared since 1981. This by itself is obviously a radical concept for appraisers who are used to taking on several hundred basis points for small stocks.

Mike also makes a strong point based on a Pastor & Stambaugh (2003) analysis that finds that “illiquidity seems to subsume all or part of the size effect.” This is because illiquid public firms tend to be small, so it may suggest that the size effect comes from an underlying liquidity effect. Liu (2006) agrees with this, but Chen, Ibbotson & Hu (2010) have a somewhat different finding—the liquidity effect does not completely capture the size effect, though it is “highly correlated with firm size.”  (Note:   For those interested in this research, Ibbotson’s work on this topic is summarized in an 10/21/10 post on called “You Can’t be too Thin.”)

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