THIS paper examines the effect of market share on the rate of return of selected firms operating in different market environments. It will be shown that the effect of share on profiltability depends on the degree of concentration and rate of growth in the industries in which the firm competes, and on the absolute size of the firm. One of the most important propositions of micro-economic theory is that under competitive conditions, rates of return tend toward equality. A casual look at the data will reveal that rates of return are not equal and that differences in rates of return often persist over time. Many studies have utilized industry concentration as a measure of market power and have analyzed the effect of concentration on industry profitability (a sizeable list may be found in Weiss (1971)). Three recent studies have looked at the effect of concentration on profitability using the firm as the unit of analysis (Federal Trade Commission (FTC), Hall and Weiss (1967), and Shepherd (1972)). Although share data is not generally available for most firms, the FTC study does examine the effect of "relative market share" (market share divided by the big four firm concentration ratio) on profitability in food manufacturing firms, while the Shepherd paper examines the effect of market share for a sample of large, nondiversified firms. The more recent of the above studies emphasize additive multiple regression models. While these models attempt to control for the effects of some dimensions of market structure when focusing on the effect of a particular structure variable, they do not capture the interaction effects of structure variables on profitability. Two independent variables are said to interact if the effect of one independent variable on the dependent variable depends on the level of the other independent variable. Interaction effects may be analyzed in the following three ways (1) specifying an interaction model, (2) including interaction variables in an additive model, or (3) by estimating the parameters of an additive model for subgroups of the total sample. A version of the third method is employed in this study and will be discussed in section I. To illustrate this subgrouping method, suppose we divide our sample into two subsamples (A) firms in highly concentrated industries and (B) firms in lowly concentrated industries. As will be explained below, we expect that the slope coefficient from a regression of profitability on share in the high concentration subgroup will be much higher and more significant than the slope coefficient from the low concentration subsample. The primary goal of this paper is to develop and test a theory of the effect of firm share on profitability under various competitive situations. We have tried to integrate, formulate, and extend some elements of oligopoly theory and to test the resulting hypotheses. The hypothesis and finding that share affects rate of return is greatly strengthened by the more complex interaction hypotheses and findings.1 In carrying out this major goal we also examine the effects of both firm and industry growth on profits, develop new evidence on leverage as a measure of risk, comment on the controversy over the correct measure of profitability, and introduce the concept of market share as a so;urce of product differentiation. The paper contains four major sections. The first section develops the theoretical relationship between share and profitability. This discussion focuses on the interaction effects on profitability of share and the market environReceived for publication September 30, 1971. Revision accepted for publication June 21, 1972. * I am indebted to Ronald G. Ehrenberg, Kenneth Gordon, Marshall C. Howard, James K. Kindahl, Thomas Muench, and George Treyz and two referees for comments and suggestions on an earlier draft of this paper and to Patricia M. Anderson for programming services and comments. ' The interaction findings, especially the growth interaction, support the case for interpreting the data in this cross-section study as representing the effect of share on profitability. An examination of the dynamic process by which firms alter their market share positions would require time-series data. (See Gale, 1972.)