The estimation of profit efficiency

ABSTRACT

This article discusses a way of solving the ‘Greene Problem’ that has been termed for a technical difficulty in estimating a profit system with technical and allocative inefficiencies. As the ‘Greene Problem’ is due to the existence of unobserved technical inefficiency interactive in a nonlinear form, the article proposes a use of homogeneity in technology to untangle the nonlinear form, enabling the estimation of a profit system as well as the identification of the source of inefficiencies.

KEYWORDS:

• Profit efficiency
• banking efficiency
• productivity
• homogeneity in technology

JEL CLASSIFICATION:

• D24
• G21
• M21

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Neither Tobit regression in the second stage nor maximum likelihood estimation (MLE)-based truncated normal distribution in the first stage corrects this bias unless a scaling factor (or a correcting factor) is introduced. For details, see Simar and Wilson (2008, 91–95).

² This problem is often termed as ‘Greene Problem’ because Greene (1980) noticed this problem and irrelevantly imposed an assumption of independence between allocative inefficiency and cost to avoid this problem.

³ The proofs of the Proposition 1 is provided in the Appendix.

⁴ The proofs of the Proposition 2 is provided in the Appendix.

⁵ Kumbhakar and Lovell (2000, 57–60 provide a complete theoretical explanation of the decomposition of profit efficiency.