Size effect and growth options over firm lifecycle

The size effect can be attributed to the relative importance of growth options versus assets-in-place in total assets. By incorporating the changing trend of growth options over firm lifecycle into the dynamic investment model developed by Berk et al. (1999), this paper demonstrates that the gradual exhausting or exercising of growth options would cause a downward pattern of size effect over firm lifecycle, while new growth options created by R&D or innovative investments can intensify size effect. Using a sample of listed firms in USA stock market during the period of 1963-2018, both cross-sectional evidence on individual stocks and time-series evidence on portfolios analysis support theoretical predictions well, and empirical findings are robust for different methodologies, different measures of the exercising/creating of growth options, and for China's stock market.