Are SMEs less efficient? A Bayesian approach to addressing heterogeneity across firms

Empirical evidence shows that large firms are generally more efficient than small and medium-sized firms. Empirical tests have evaluated cost efficiency while assuming homogeneity among firms and mainly examined the size-efficiency relationship in a hypothetical average firm. However, in practice, firms have different resources for multiple reasons and are therefore heterogeneous. This paper uses the concept of profit efficiency to study size-efficiency relationships in individual firms while assuming heterogeneity among firms. For this purpose and in contrast to the traditional approach, we estimate a stochastic frontier model with random coefficients using Bayesian techniques to assess the differences in profit efficiency between small and large firms in the manufacturing industry in Spain. The results show that the relationship between efficiency and size heavily depends on the internal properties and characteristics of the firm and environment in which it operates and that there is heterogeneity among firms; ignoring such heterogeneity can lead to an overestimation of inefficiency of 4.92 percentage points. We also discuss the implications of these results.