Abstract
Considerable research reports that small firms typically yield higher stock returns than
large firms, though this varies over time. The size premium is usually attributed to higher risk in
smaller firms. The paper documents that the risk is to future earnings growth: Typically, smaller
firms have higher expected earnings growth, but that growth has higher risk of not being
realized. However, the size premium flips with large firms sometimes exhibiting relatively high
growth at risk. This explains the variation in the size premium over time and its reported decline
since the early 1980s. Accounting fundamentals convey the risk, so the risk and the potential flip
in the size premium can be identified ex ante from firms’ financial statements.