ACRN Journal of Finance and Risk Perspectives
Vol. 6, Issue 4, ISSN 2305-7394
Online first (full issue will be online soon):
Estimation of a Firm’s Optimal Scale of Operations and Size-Related Analyses
Mohamed Ihab Kira
Department of Financial Management and Accounting Arab Academy for Science, Technology and Maritime Transport (Dokki Branch)
Abstract: The paper proposes a framework that can be utilized for deciding upon the optimal scale of operations for a firm. The basic premise of the paper is that a firm that operates in a stable economic environment and a stable mode of business operations experiences a varying elasticity of scale that, after some scale level, becomes less than one and continues to decline with further increases in scale. A firm operating in such a stable system can search for its optimal scale of operations. The paper's premise does not refute the possibility that a firm can experience a shift from a lower elasticity of scale to a higher one; but this shift is not part of the mechanics of a stable system. Rather, it is due to some shock to the economic environment and/or the firm's mode of operations. Firms that operate under the assumption that they face a constant elasticity of scale, when in fact the elasticity varies, expose themselves to detrimental consequences. The model is in congruence with the Tobin's q criteria and can shed some light on why average q is a poor estimate for marginal q. The model sheds some light on the small-firm effect and on a major difference between internal and external growth.
Keywords: optimal scale, elasticity of scale, Tobin's q, small-firm effect, internal growth, external growth