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A number of universities in Taiwan are currently confronting problems of low enrolment rates and financial distress mainly as a result of low birth rates and over-expansion of the higher education industry over the last few decades. These universities were requested by the Taiwan Ministry of Education to find a solution, including shutting down problematic departments and merging with other institutions. As such, information on cost efficiency and the optimal size of universities is important for making appropriate decisions. A stochastic cost frontier approach is adopted in the study to measure the cost efficiency and identify optimal size of Taiwanese universities by considering the heterogeneity of university quality. The results of the study indicate a positive correlation between the optimal size and the university quality. Approximately 47 percent of the selected universities are identified as either over- or under-sized. Moreover, the magnitude of cost saving from efficiency improvement is found to be no smaller than that of size adjustment. Therefore, it is suggested that universities should put more effort into efficiency improvement while considering size adjustment. • The objective of study is to measure the cost efficiency and identify optimal size of Taiwanese universities. • A stochastic cost frontier approach is adopted in the study. • A positive relation exists between university quality and average cost. • The magnitude of cost saving from efficiency improvement is similar that from size adjustment. [ABSTRACT FROM AUTHOR]