What does the term "size premium" refer to in finance?

The term "size premium" in finance refers to the additional return that investors expect to receive from investing in smaller companies compared to larger companies. This premium is often justified by the higher inherent risks associated with smaller firms, including factors such as market volatility, less established business models, and lower access to capital.

Investors demand a size premium as compensation for the uncertainties and risks they take on when choosing to invest in smaller companies rather than larger, more stable ones. In many models of expected returns, particularly in asset pricing theories, size is considered a factor that can influence the risk-return trade-off for investors.

In this context, the size premium highlights the relationship between company size and investment return potential, reinforcing the understanding that smaller companies typically face greater risks yet have the potential for higher returns, thereby attracting some investors who seek the rewards that come with those risks.