A revisit to firm profitability-size relationship in the presence of firm financial leverage
by Zhixin Kang; Edwin Clifford Mensah; Rebecca Gonzalez-Ehnes
International Journal of Accounting and Finance (IJAF), Vol. 11, No. 2, 2022

Abstract: Existing literature reports that in one industry sector a firm's profitability rate declines when it gets to a larger size and points to firm financial leverage as a possible causing factor. However, in our knowledge, no subsequent studies provide further evidence on this hypothesis. This study fills this void by revisiting firm profitability-size relationship in the presence of firm financial leverage. Using quarterly panel data, which covers 326 publicly listed US firms in eight industries with data observations spanning from Q1 of 1984 to Q1 of 2021, we split financial leverage into different regimes in an econometric approach and study the impacts of financial leverage on firm profitability-size relationship in each regime. We find the evidence that in the different regimes of financial leverage, the sensitivity of firm profitability to size remarkably exhibits heterogeneous patterns. Furthermore, when financial leverage moves from a low-ratio to high-ratio regime, the contributing strength of firm size to firm profitability weakens. Our study reveals a nonlinear pattern in the firm profitability-size relationship in the presence of financial leverage.

Online publication date: Tue, 13-Jun-2023

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