We examine differences in structural characteristics that lead firms of different sizes to react differently to the same economic news. We find that a small firm portfolio contains a large proportion of marginal firms—firms with low production efficiency and high financial leverage. We construct two size-matched return indices designed to mimic the return behavior of marginal firms and find that these return indices are important in explaining the time-series return difference between small and large firms. Furthermore, risk exposures to these indices are as powerful as log(size) in explaining average returns of size-ranked portfolios.
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