My recent post on the small-cap premium and my tentative hypothesis that sub-linear scaling in companies helps to explain it has received a substantial amount of interest — privately, publicly, and even a bit in the comments. Due to the remarkable response, I wanted to add a few clarifying points.
- I don’t suggest that the sub-linear scaling Geoffrey West discovered within companies fully explains the small-cap premium. There are a number of factors at work (including risk, the standard explanation for the small-cap premium), and these can cut in a variety of ways.
- Most of the criticism centers upon the (very tentative) conclusion rather than the data. If the data is accurate — and I see no reason to doubt it to this point — it suggests that smaller companies, once they have reached something like critical mass, are decidedly more efficient than larger companies. That added efficiency, if and when fully verified, would indeed support both the existence and the persistence of a small-cap premium. Those who disagree with the (again — very tentative) conclusion must still account for the data. To this point, none of the critics has even made an attempt to do so.
- Further discussion and (especially) further research will be necessary to see if this idea holds up. I emphasize that it remains merely a hypothesis to this point. It seems consistent with and supported by the data but remains in need of verification.
As always, comments and criticisms remain welcome.
Bob, I am not in any way a scientist, but in my years as a turn-around advisor, I often saw how much more commitment the SME director and board bring to the game. So, I am not so sure that what you have observed is a true efficiency, as in scale returns and those sort of things; it may just be the simple effect of working harder, longer and, sometimes, with more desperation, at making the company work.
Thanks for reading and commenting. I’m pretty sure you’re onto something, particularly given your experience, but I suspect it’s something *more* because West’s findings were universal. In any event, further research should be able to establish what’s going on.
I posted one of the comments yesterday. I don’t know what others have told you but I think your clarifications, above, are helpful.