Employment growth and profitability in European SMEs: the 100% speed limit

ABSTRACT

We investigated the relationship between employment growth and profitability and propose that small and medium-sized enterprises (SMEs) hire employees, they experience an increase in profitability due to their acquisition of additional human capital. These benefits, however, are limited by the firm’s ability to efficiently integrate the newly recruited employees and adjust its internal managerial practices and organization accordingly. Using a large sample of SMEs in the European Union, we examined the relationship between employment growth and profitability as a quadratic function with an inverted U shape. The empirical results strongly supported our prediction as we observed that profitability decreased when SMEs exceeded a 100% growth rate in employment. Importantly, we observed strong homogeneity in our results across various industries. This paper empirically documents the ‘maximum’ speed at which firms should grow and highlights the homogeneity of this result across industries.

KEYWORDS:

• Growth
• employment
• profitability
• resources
• SMEs
• human capital

Acknowledgments

This research benefited from the support of the Réseau de Recherche et d’Expertise en Entrepreneuriat and the Région Grand Est. The author wishes to thank the editor, Natalia Vershinina, and two anonymous reviewers for helpful comments. All remaining errors are the author’s own.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. Other important theories in firm growth research include the stage-of-growth theory by Greiner (1972) and the evolutionary theory by Jovanovic (1982). These theories are more common in economic research than management research.

2. Other views of growth as a process exist in the literature. For instance, Chandler, McKelvie, and Davidsson (2009) studied the reverse relationship (between growth in sales and growth in employment) using transaction costs theory as their theoretical framework. They argued that growth in employment is only possible if critical levels of sales and cash flows are previously reached because hiring new employees comes at a cost. Their paper focused on very small firms with an average of five employees.

3. Coad et al. (2020) considered growth in sales and not growth in employment.

4. A notable difference is the role played by seniority rules in layoff procedures. While some of the countries we considered have such rules (France, Italy, or Sweden, for instance), it is not the case in all countries. See von Below and Thoursie (2010) for a detailed discussion.

5. Full documentation as well as the index itself are accessible at: https://www.oecd.org/els/emp/oecdindicatorsofemploymentprotection.htm

6. In unreported estimations, we used instrumental variables as a robustness test. We obtained results similar to those of the fixed-effects model for two of our three dependent variables. We used the annual mean industry growth in employment and the annual mean regional growth in employment as instruments.

7. We ran a Hausman test and the chi-squared statistics was 22,158.78 (p < 0.001). We thus rejected the null hypothesis that the coefficients of the random-effects and fixed-effects models were the same and opt for a fixed-effects model.