The Effect Of Firm Size On Profitability

Abstract

Firms in a market economy vary widely in size, performance, and survival. What are the factors determining these observed variables and how they operate has been active topic of research in industrial organization and more generally in developing country where Pakistan is one of them. The purpose of this study is to investigate the effect of firm size on profitability of the firm. In this study, panel data was collected of 27 companies, which were listed in Pakistan Stock Exchange Limited (PXL. ) in sugar and allied sector,between the years 2010-2015 has been used. Firm size has been considered as an important determinant of firm profitability. Return on Assets (ROA) has been used as indicators of firm performance means profitability and total sales, total assets and total firm capital and market share have been used as proxies of firm size. Multiple regression methods have been used in empirical analyses. The result of analysis indicates that there is a positive relationship between firm size indicators total assets, total sale, total capital of firm, market share and profitability of firm.

Keywords

Firm size, Firm performance, Firm Profitability, Sugar and Allied Industries Pakistan Stock Exchange Limited (PXL. ).

Introduction

The size of a firm plays an important role in determining the kind of relationship the firm enjoys within and outside its operating environment. Normally the studies says that there is a positive relationship between the firm size and the firm performance. Means high sized firm will be more productive then smaller, and will be more profitable. when the profit of the firm will be greater the focus oar intention of shareholder oar investers will be toward the firm. Refocusing the importance of size in corporate discourse, Bhayani, (2010) said that an interesting aspect of economic growth is that much of it takes place through the growth in the size of existing organizations. The combine study of Rajan and Zingales (1995) whose study with the sample of 43 countries industries that shown, they said two third growth of industries sector is increase the size of the firm, and only one third is due to the new business mans in the market. So they also said if the size of firm will be increased, it will be more profitable rather than the firm that will be established as a new firm. Having large size have the more productivity oar more production oar can say more compatitative rather then the smaller size firms.

They can compete and can kick out the new comers with in few month due to hold on market with in few months. Larger size firm have a great opportunity to investment more reliable more productive, more trustable, more competitive. If we talk about the size of the firm, there are so many ways through which we can calculate the size of firm, but the best one is that the proxies of total sale, total assets, total firm capital and total market share. If we talk about the profitability of the firm there are also so many methods but here we have used the term, return on assets as the firm performance. Firm performance is our dependent variable, and the firm size is our independent variable. In this context, size has been considered as a fundamental variable in explaining firm profitability by the researchers and a number of studies investigate the effects of size on firm profitability (Serrasqueiro et al, 2008; Wu, 2006). Here, it should be stated that according to the conclusions of various studies the impacts of size on profitability can be negative or positive (Serrasqueiro et al, 2008).

Forasmuch as some authors argue that larger firms have some advantages such as a greater possibility of taking advantage of scale of economies which can enable more efficient production (Hardwick, 1997; Fiegenbaum and Karnani, 1991), a greater bargaining power over both suppliers and distributors or clients, exploiting experience curve effects and setting prices above the competitive level (Fiegenbaum and Karnani, 1991). It is also argued that larger firms are more stable and mature and they can generate greater sales because of the greater production capacity that will enhanced capital cost savings with the economies of scale (Ravenscraft and Scherer, 1987). On the contrary, some authors claim that size may have no or negative impacts on profitability (Shepherd, 1972), especially if growth in size causes a diseconomies of scale (Goddard et al. , 2005). As per earlier studies controversy, Shepherd (1972), Becker et al. (2010), Banchuenvijit (2012) have found that negative relationship between firm size and performance. Other than above studies, Simon (1962), Whittington (1980), Khatap et al. (2011) have analysed that firm size does not have an affect on performance. These results cause a vague understanding of the affect of firm size on profitability and also an increase in the interest toward this subject. Our Study have five sections. The studies measuring the affect of firm size on profitability have been summarized in the second section following the introduction. Third section consists of introduction of dependent and independent variables and explanation of methodology and sampling of the study. Forth section contains the results of analysis. And a general assessment of the study has been put forth in the last section.

Literature Review

One of the first studies investigating the affect of firm size on profitability has been carried on by Simon (1962). Simon (1962) was not able to find a statistically significant relation between profitability and firm size. On the other hand, Hall and Weiss (1967) have found a positive relation between firm size and profitability in the study they carried on over Fortune 500 firms. On the contrary, Shepherd (1972) has found a negative relation between firm size and profitability. Whittington (1980) argued that firm profitability is independent from firm size. Özgülbaş et al. (2006) have studied the affect of firm size on performance over the firms operating in Istanbul Stock Exchange between the years of 2000-2005. They have found that big scale firms have a higher performance as a result of their study. In a similar fashion, Jonsson (2007) has studied the relation between profitability and size of the firms operating in Iceland. Results of the analysis have showed that big firms have a higher profitability compared to small firms. Khatap et al. (2011) have studied the relation between performances and corporate governances of 20 firms which have been listed in Karachi Stock Exchange. The results of the study using the data of the period between the years 2005-2009 have showed a positive relation between total assets and ROA, but a negative and statistically not significant relation has been found between ROE and total assets.

In addition, Karadeniz and İskenderoğlu (2011) have analyzed the variables affecting the return on assets of the tourism businesses listed in ISE. Results of the study showed that there are positive and statistically significant relations between total assets which has been used as a size indicator and ROA. In a similar way, Saliha and Abdessatar (2011) have studied the factors affecting profitability of 40 firms operating in Tunisia between the years of 1998-2006. As a result of their study, a positive relation has been shown between firm profitability and size. By employing a sample of 200 listed firms in Borsa Istanbul Stock Exchange (BIST) during 2008-2011, Doğan (2013) investigate the relationship between firms size indicators represented by total assets, total sales and number of employees and firm performance represented by return on assets in Turkey. Estimation results imply that each of size measures really influence returns on assets of firms, i. e. , size indicators are positively and significantly associated with return on assets. A sample of 15 listed firms operating in manufacturing industry in Sri Lanka over the period 2008-2012 is studied by Niresh and Velnampy (2014) with the aim of assessing the relation of size-profitability.

Data and Methodology

Sample: We used a panel data of 27 firms of sugar and allied industries listed in Pakistan Stock exchange (PXL. ) between the years 2010 to 2015. The aim of this study is to investigate the affect of firm size on profitability. Data was collected from the website of Pakistan Stock Exchange Limited (PXL. ) Analysis does not include the companies operating in financial sector due to their different financial structures. Multiple regression methods have been used in empirical analyses. Durbin-Watson d statistic has been used to test if there is an autocorrelation of first degree between the error terms of the sample, also performed many other tests that decrease the biasness of data. Variables: As earlier defined, the main aim of the present study is to analyze the effects of firm size on profitability. In order to achieve this purpose; the dependent variable, profitability is measured by using Return on Assets (ROA). ROA is calculated as the net profit after tax divided by total assets and indicates the returns generated from the assets financed by the firm. In this sense, ROA represents the ability of firm’s management to convert firm’s assets into net profits and size constitutes the principal independent variable of the study.

The z-value of total assets is 2. 5, total sales 2. 47, total capital 3. 11 and market share 4. 15 which are greater than 2 according to rule of thumb and all results are significant. There is positive relation between Total sales and Return on assets and significant, if sales increases, return on assets also increases. There is positive relation between Total assets and Return on assets and significant, if total assets increases, return on assets also increases. There is positive relation between Total capital and Return on assets and highly significant, if total capital increases, return on assets also increases. There is positive relation between Market share and Return on assets and highly significant, if market share increases, return on assets also increases. The coefficient of determination is R2 is 43%. This regression equation ables to explain about 43% the variation in dependent variable (ROA) due to explanatory variables (TA, TS, TC and MS). According to Past Researchers findings larger firms have higher profitability than smaller firms. The estimation of linear and quadratic coefficients on firm size is negative but at conventional level is significant.

According to Amato (2004), the researchers investigated whether there is cubic relation between firm size and profitability. The results about total assets and total sales size is positive related to profitability of firms. The firm size has a positive impact on the profitability of Nigeria manufacturing listed companies in Stock Exchange.

Conclusion

In this regression analysis, we take 162 observations, 27 groups and explanatory variables to check validity of the data. In this regression model, we take data of sugar sector from stock exchange. We take panel data and used stata for finding results. Total assets has positive relation with profitability, higher the total assets higher the profitability. Total sale has positive relation with profitability, higher the sales higher the profitability. Total capital and market share also have positive relation with profitability, higher the capital and market share higher the profitability. All variable have significant relations. It means larger the firm size larger the profitability.

The results of panel data models provides econometric evidence that exists size effect in manufacturing industry in Turkey during period under consideration. In future studies, the impact of the size of the firm on profitability would be empirically analysed in terms of other sectors as well as financial sector in the Borsa İstanbul. Limitations and Future study: This study is not enable to apply on all industrial sector, might be possible every industrial sector have different characteristics about the running process, financial control, fusibility, and so many other rules and regulations. Its also might be possible error and omissions exist in this study due to our lack of knowledge. You can analyse other industrial sector like this. In Pakistan there are limited number of studies in this topic.