STRUCTURAL AND RETURN CHARACTERISTICS OF SMALL AND LARGE FIRMS

We examine differences in structural characteristics that lead firms of different sizes to react differently to the same economic news. We find that a small firm portfolio contains a large proportion of marginal firms—firms with low production efficiency and high financial leverage. We construct two size‐matched return indices designed to mimic the return behavior of marginal firms and find that these return indices are important in explaining the time‐series return difference between small and large firms. Furthermore, risk exposures to these indices are as powerful as log(size) in explaining average returns of size‐ranked portfolios. 1991 The American Finance Association