Considerable research reports that small firms typically yield higher stock returns than large firms, though this varies over time. The size premium is usually attributed to higher risk in smaller firms. The paper documents that the risk is to future earnings growth: Typically, smaller firms have higher expected earnings growth, but that growth has higher risk of not being realized. However, the size premium flips with large firms sometimes exhibiting relatively high growth at risk. This explains the variation in the size premium over time and its reported decline since the early 1980s. Accounting fundamentals convey the risk, so the risk and the potential flip in the size premium can be identified ex ante from firms’ financial statements.
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