Does the Entry Mode of Foreign Banks Matter for Bank ... - EconomiX

The ability of managers to convert inputs into outputs is often influenced byexogenous variables that characterize the environment in which production takes place.The question then is how to account for these environmental factors?There are three competing approaches regarding the way the issue of environmentis addressed.Environmental factors in the production frontierThe first approach assumes that the environmental factors influence the shape ofthe technology. Therefore, these factors should be included directly into the nonstochasticcomponent of the production frontier (e.g., Good et al. (1993)). This leads to amodel of the formln qi= x β + z γ + v − u'i'iwhere z i is a vector of (transformations of) environmental variables and γ is a vector ofunknown parameters. In this case, it is assumed that each firm faces a differentproduction frontier.Environmental factors in the inefficiency termThe second approach assumes the environmental factors influence the degree oftechnical inefficiency (and not the shape of technology) and hence that these factorsshould be modeled so that they directly influence the inefficiency term 6 . The underlyinghypotheses is that all firms share the same technology represented by the productionfrontier and that the environmental factors have an influence only on the distance thatseparates each firm from the best practice function.Early empirical papers (e.g. (Pitt & Lee, 1981) and (Kalirajan, 1981)) explore therelationship between environmental variables and predicted technical efficiencies using atwo-stage approach. In the first stage, the firm-specific inefficiency effects assumed to beidentically distributed are retrieved from the estimated stochastic frontier. In the secondstage, the predicted inefficiencies are used as a dependent variable in a regression modelin which explanatory exogenous variables seek to explain differences in these effects(e.g. (Mester, 1993)). This approach is subject to two main weaknesses. One is that, inthe first stage, when the production or cost relationship is estimated, the efficiency termsii6 For a comparison of these two approaches, see Coelli et al. (1999).-20-