Employees, Firm Size and Profitability of U.S. Manufacturing Industries

We examine the relation between firm size and profitability within 109 SIC four-digit manufacturing industries. Depending on our measure of profitability, we find that profitability increases at a decreasing rate and eventually declines in up to 47 of our industries. No relation between profitability and size is found in up to 52 of our industries. These two categories account for 97 of our 109 industries. Profitability continues to increase as firms become larger in up to 11 industries. Hence, the relation between size and profitability is industry specific. But, regardless of the shape of the size profitability function, we find that profitability is negatively correlated with the number of employees for firms of a given size measured in terms of total assets and sales. These results are puzzling in the context of work by others who report that common stock returns are negatively correlated with size when size is measured by the market value of a company or with the work of those who argue that size is a proxy for risk. Interpreted against these works, our findings may mean that large firms earn excess returns, that small firms fail to earn their cost of capital, or that accounting returns simply behave differently than market returns with respect to firm size