The size and growth of firms: new evidence on law of proportionate effect from Asia
| Pages | 91-108 |
| DOI | https://doi.org/10.1108/JABS-12-2018-0348 |
| Date | 10 January 2020 |
| Published date | 10 January 2020 |
| Author | Inder Sekhar Yadav,Debasis Pahi,Phanindra Goyari |
| Subject Matter | International business,Strategy |
The size and growth of firms: new
evidence on law of proportionate
effect from Asia
Inder Sekhar Yadav, Debasis Pahi and Phanindra Goyari
Abstract
Purpose –This paper aims to investigate the relationship between firm size and growth under the
frameworkof Law of Proportionate Effect (LPE) forAsian firms.
Design/methodology/approach –An unbalanced panel data for about 12,001 unique non-financial
listed and activefirms from 1995 to 2016 for 12 industrial and emerging Asianeconomies was examined.
Total assets and net sales were usedas size variables. Firm-specific variables such as return on equity,
leverage and liquidityratio were used along with macroeconomic variablessuch as GDP growth and two
financial developmentindicators. The fixed effects and random effects approach were usedto estimate
the dynamic growthmodel after taking into account econometricissues such as correlation between the
cross-country-specificerror componentand the regressors and heteroscedasticity.
Findings –The estimated coefficient of firm size was found to be always significant and negative
rejecting the Gibrat’s law for Asian firms confirming that the small-sized firms are growing faster than
larger-sized firms. Also, the persistence of growth coefficient suggested that a positive persistence of
firm growth does not exist for the selected Asian firms. Gibrat’s LPE was also rejected across small,
medium- and large-sizedcompanies. For the aggregate sample, the coefficientof leverage was found to
be negative and significant, whereas liquidity ratio, GDP growth, banking sector and stock market
variables are found to have positive and significant relationship with growth of firms. For individual
economies, a mix of positive and negative (significant and insignificant) estimated coefficient was
observed.
Practical implications –At macro-level,the examination of firm growth is likely tohave significant policy
implications for the regulatorsand various government agencies as firm growthmay increase economic
activity in general and employment opportunities in particular. The policymakers can controleconomic
and employment activity by designing specific firm growth policies. At micro-level, the study will have
significantimplications for managerial decision-making.
Originality/value –To the best of the authors’knowledge, this is one of the first studies to test the validity
of Gibrat’s LPE for large Asian economies and firms using recent data under a dynamic growth
framework using firm-specific and macroeconomic variables.Also, persistence of growth of firms under
LPE (thatgrowth does not persist from one periodto the next) is uniquely examined for Asianfirms.
Keywords Panel data, Growth, Firm size, Asia, Law of proportionate effect
Paper type Research paper
1. Background
In recent years, firm growth and limits to firm growth and size have received considerable
prominence in economic literature. Like the biological growth of living organisms, firms also
have different stages of growth in their life cycle. For instance, firms are born in the market,
stand, struggle, survive, grow and eventually die. Thus, the growth of firms mainly reflected
by its size is crucial and important for its existence and survival. During business
operations, firms tend to grow and enlarge the size that gives them perfect control over its
business environment. For example, a continuously growing firm (in size) may be able to
Inder Sekhar Yadav and
Debasis Pahi are both
based at the Department of
Humanities and Social
Sciences, Indian Institute of
Technology Kharagpur,
Kharagpur, India.
Phanindra Goyari is based
at the School of Economics,
University of Hyderabad,
Hyderabad, India.
Received 30 January 2019
Revised 29 May 2019
Accepted 28 October 2019
DOI 10.1108/JABS-12-2018-0348 VOL. 14 NO. 1 2020, pp. 91-108, ©Emerald Publishing Limited, ISSN 1558-7894 jJOURNAL OF ASIA BUSINESS STUDIES jPAGE 91
enhance its market share in the industry which will further have positive effects on the
earnings of the firm. Also, the firm may be in a dominant position to introduce new
production processes and products and new organizational systems which will augment
the competitive power of the firm which will enable it to stand or survive in the competitive
world. Also, large firms due to their large scale of operations may enjoy economies of scale
reducing the cost of production and increasing the efficiency of its overall production
activities. Therefore, growth (size) is very much desirable for a corporate firm to stay in
business otherwise the dynamic competitive forces of the market will relegate it to non-
entity.
Over the years, several empirical studies attempted to examine and understand the
dynamics of firm and evolution of industry for different economies at different periods. For
example, studies like Geroski (1995),Sutton (1997) and Caves (1998) have madeimportant
empirical observations on firm dynamics, the evolution of industry, entry and exist of firms
into an industry, growth, and stagnation and finally survival of firms. Particularly, in
understanding the growth process of firms, the relationship between the size and growth of
firms has gained prominence where the twin ideas of the optimum size of the firm and
industrial equilibrium are involvedand applied (Singh and Whittington, 1975).
However, according to Marris (1963), in context of the division of ownership and
management, the goal of the firm is the maximization of the balanced rate of growth of
the firm, as salaried managers will be less interested in maximizing the profits of the firm
(Singh and Whittington, 1975). This particular framework suggests a positive association
between firm size and growth on a cross-sectional basis signifying that there is no limit to
the absolute size of the firm, but there does exist a limit to its growth rate per unit time
(Singh and Whittington, 1975). This is because larger size firms will be dominated more
by managers than owners and therefore grows more compared to small firms which are
plausibly controlled by owners and hence less interested in growth.
Also, the association between firm size and growth can be observed from a different
dimension as propounded by Gibrat (1931) which is popularly known as the Law of
Proportionate Effect (LPE). The LPE simply says that the probability of a firm growing at a
given proportionate rate during any specified period is independent of the initial size of the
firm (Singh and Whittington, 1975). In other words, “the probability of a given proportionate
change in size during a specified period is the same for all firms in a given industry
regardless of their size at the beginning of the period” (Mansfield, 1962, p. 1031). In this
framework, firm growth is consideredas a stochastic multiplicative growth process (Oliveira
and Fortunato, 2006) resulting from the cumulative effect of the chance of operation of a
large number of factors independently acting of each other (Singh and Whittington, 1975).
This happens because the chance of growthor no growth of any individual firm depends on
the host of factors such as profitability, managerial quality, availability and mix of factors of
production, the variety of its products, the business environment and so on. During any
particular period, some of these factorstend to increase the firm size whereas some tend to
decrease. Accordingly, the collective effect of these factors would produce a probability
distribution of the rates of growth (or decline) for firms of each given size. Thus, it is
therefore generally stated that for all size-classes of firms this probability distribution is the
same (Singh and Whittington,1975).
The economic implication of LPE is that small, medium and large firms will have the same
average proportionate rates of growth during any particular period (Hart, 1962). Thus, if the
LPE holds then the growth of the firm can be considered as a stochastic process and
therefore, there will not be the optimum size of the firm. Also, in its strongest form, LPE
advocates that the rate of firm growth in one period has no influence in the subsequent
periods of its growth. Furthermore, the stochastic processes derived from the LPE
approximately explain the observed size distributions of firms, which from widely different
populations have been known to approximate the Pareto or log-normal distributions.
PAGE 92 jJOURNAL OF ASIA BUSINESS STUDIES jVOL. 14 NO. 1 2020
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