The economic and stock market landscape is, by its very nature, made up largely of small companies (known as ‘small-caps’ and ‘mid-caps’ in stock market jargon). It is therefore important to know whether investors perceive these companies as carrying a higher risk and demand a higher rate of return than that offered by large companies – in other words, whether they command a size premium.
The world of finance is no stranger to controversies regarding the factors to be taken into account when calculating the cost of equity (which benchmark should be used to determine the risk-free rate, should a historical, a forecast risk premium or one based on a market consensus, over what time horizon should the beta be calculated…?). The size premium is no exception, insofar as the existing debates do not merely concern how to take it into account, but its very justification. Many practitioners, asset managers and academics indeed dispute the existence of a yield differential between small and large companies.
by Teddy Guérineau
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