American Journal of Health Sciences – Fall 2011 Volume 2, Number 2 © 2011 The Clute Institute 75 Productive Efficiency And Optimal Firm Size: The Case Of US Health Services Industry 1 Emmanuel Ajuzie, Lincoln University, USA Adam Bouras, Graduate Student, University of Missouri-Columbia, USA Felix Edoho, Lincoln University, USA David Bouras, Lincoln University, USA Aloyce Kaliba, Southern University and A&M College, USA Roberto Ike, Lincoln University, USA Abhirjun Dutta, University of California, Davis Medical Center, USA ABSTRACT This paper examines the link between firm size and productive efficiency. In so doing, it attempts to determine optimal firm sizes in terms of market capitalization and total asset thereby allowing firms to achieve higher level of productive efficiency. The results indicate that the optimal firm size in terms of market capitalization is $13.1 billion. In terms of total asset, the optimal firm size is $10.3 billion. The results also suggest that there is a threshold above which an increase in firm size adversely affects the level of productive efficiency. The results have important implications for managerial policies regarding firm restructuring. To achieve higher productive efficiency, smaller firms have to pursue expansion strategies through mergers and acquisitions. Larger firms, on the other hand, have to pursue divestment strategies to reduce the size of their assets, particularly by refocusing on core competencies. Keywords: Productive Efficiency; Optimal Firm Size; Health Services Industry; Market Capitalization 1. INTRODUCTION n the healthcare debate, which began in 2009 when the Obama Administration took over the mantle of power in Washington and continued with intensity through the first quarter of 2010, many reasons were given to explain why US healthcare system needs revamping. The most important argument is the cost of healthcare, which is absurdly high relative to other developed nations. The unfortunate irony is that with such unprecedented astronomical costs, the US still has very many uninsured citizens who desperately need health insurance. Different people have blamed inefficiency in the system as the main cause of the continuously rising healthcare costs. Our objective in this paper is to empirically investigate the level of productive efficiency in the US health services industry. In particular, we focus on the link between firm size and productive efficiency. Productive efficiency or technical efficiency is a measure widely used to describe the relationship between the level of output and the amount of input used in the production process. The level of firm’s productive efficiency is of particular relevance because it provides an insight into resources allocation and has implications for firm financial performance. The extant literature that analyzed the effect of firm size on productive efficiency found mixed results. While one stream of research found a negative correlation between firm size and the level of productive efficiency (e.g., Soderbom and Teal 2004), another stream of research found a positive correlation 1 An earlier version of this paper titled “The effect of firm size on efficiency: Evidence from US Health Services Industry” was presented at the International Academy of Business and Public Administration Disciplines (IABPAD), Conference, Orlando, Florida, January 3-6, 2010. We thank seminar participants for their helpful comments and suggestions. I