Specification, Heterogeneity and Functional Form in the Determinants of Small-Firm Profitability

Operating structure, not financing, is the main determinant of profitability in small firms. This study reaches that conclusion by comparing, in the same model and on the same scale, two explanations offered for why some small firms earn more than others how they are financed and how they organise their costs. Existing studies focus almost entirely on financing and treat costs as a background control. The evidence comes from a large panel of unlisted Italian firms observed between 2014 and 2025, including innovative start-ups, innovative SMEs and conventional firms, and each result is checked with three independent types of analysis. Firms that devote a larger share of the value they create to wages earn systematically less, in every type of firm. Part of this link reflects how profits are recorded in the accounts. The link between equity and profitability, by contrast, is weak and its direction cannot be established, because profitable firms accumulate equity and cause and effect cannot be separated. Profitability is also determined differently across groups of firms fall into distinct operating profiles. Support schemes for innovative firms that focus on access to finance may therefore be addressing the wrong constraint.