Work in groups of max 4 students.

Grading rules are as follows:

Score >=9 => ++++ (4 bonuses) for the mid-term
Score >=7.5 => ++
Score <=4 => - - - (3 minuses)

In-class Exercise

This exercise investigates the determinants of firm performance which is measured by returns
on equity using the data of 21 countries around the world between 2005 and 2012. Use the data
PER0512.DTA to answer the following questions:
1. Find Mean, P25, P50, P75 of roe. What are the meanings of P25 and P75?

2. To investigate the determinants of firm performance, we estimate the model by OLS.

Please report the results in equation form (coefficients, standard error), also provide the
sample size and R2
𝑟𝑜𝑒 = 𝛽0 + 𝛽1 𝑠𝑖𝑧𝑒 + 𝛽2 𝑓𝑖𝑟𝑚_𝑎𝑔𝑒 + 𝛽3 𝑙𝑒𝑣𝑒𝑟𝑎𝑔𝑒
+ 𝛽4 𝑠𝑎𝑙𝑒𝑠𝑔𝑟𝑜𝑤𝑡ℎ + 𝛽5 𝑡𝑎𝑛𝑔𝑖𝑏𝑙𝑒 + 𝛽6 𝑏𝑜𝑎𝑟𝑑_𝑠𝑖𝑧𝑒
+ 𝛽7 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙𝑓𝑟𝑒𝑒𝑑𝑜𝑚 + 𝛽8 𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛 + 𝑢

Notes:
size=log(total assets); firm_age=log(1+ years in corporation); board_size=log(numbers of
directors on board); leverage ratio, sales growth (%), tangible (ratios of tangible assets to total
assets), financial freedom index, corruption index.
3. Explain the intercept. Does the intercept have intrinsic meaning?
4. Interpret the coefficient of size, sales growth, financial freedom and corruption.
5. Using the standard normal approximation, find the 99% confidence interval for
𝛽5 (𝑡𝑎𝑛𝑔𝑖𝑏𝑙𝑒)
6. At 1% significant level, test the hypothesis that firm performance (roe) does not change
with firm size (size) against the alternative that it increases with firm size.
7. Does corruption have a significant effect on roe at 1% significant level?
8. Can we reject the hypothesis H0: 𝛽𝑙𝑒𝑣𝑒𝑟𝑎𝑔𝑒 = −0.2 against two-sided alternative at 5%?
9. At 1% significance level, test the hypothesis that a one unit increase in tangible leads to
one unit decrease in roe.
10. Comment the determinants of firm performance. Which variables are significant and which
percentage of significance level? Which variables are not significant?
11. State the hypothesis and test whether leverage and salesgrowth have the same effect on
roe
12. State the hypothesis and test whether 𝛽3 = 𝛽4 = 𝛽5 = 𝛽6 = 0? What can you conclude
about this hypothesis?
13. Can you reject the null hypothesis 𝛽4 = 0.1, 𝛽6 = 0 in favor of alternative hypothesis?
14. Test the overall significance of coefficients.
15. Find correlation matrix between variables. Please check whether multicollinearity problem
exists in the model. If yes, how to solve?
 Solutions
1.

P25=0.065 => about 25% of observations that has roe < 0.065
P75=0.218 => about 25% of observations that has roe >0.218

2.
𝑟𝑜𝑒
̂ = .037 + .012 𝑠𝑖𝑧𝑒 + −.003 𝑓𝑖𝑟𝑚𝑎𝑔𝑒 − .168 𝑙𝑒𝑣𝑒𝑟𝑎𝑔𝑒
(. 041) (. 003) (. 006) (. 027)
+.076 𝑠𝑎𝑙𝑒𝑠𝑔𝑟𝑜𝑤𝑡ℎ − .065 𝑡𝑎𝑛𝑔𝑖𝑏𝑙𝑒 + .015 𝑏𝑜𝑎𝑟𝑑𝑠𝑖𝑧𝑒
(.012) (.018) (.013)
+.001 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙𝑓𝑟𝑒𝑒𝑑𝑜𝑚 − .041 𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛
(.0004) (.009)
𝑛 = 2595, 𝑅 2 = .059

3. Intercept = 0.037, if all independent variables =0, roa=0.037. No intrinsic meaning

because all Xs cannot equal 0 at the same time.

4.
𝛽𝑠𝑖𝑧𝑒 = .012, holding all other factors fixed, 1% increase in total assets is associated with an
increase in roe by 0.012/100=0.012%
𝛽𝑠𝑎𝑙𝑒𝑠𝑔𝑟𝑜𝑤𝑡ℎ = .076, holding all other factors fixed, 1 unit increase in sales growth is
associated with an increase in roe by 0.076 =7.6%.
𝛽𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑓𝑟𝑒𝑒𝑑𝑜𝑚 = .001, holding all other factors fixed, 1 unit increase in financial
freedom is associated with an increase in roe by 0.001 =0.1%.
𝛽𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛 = −.041, holding all other factors fixed, 1 unit increase in corruption is
associated with a decrease in roe by 0.041 =4.1%.

5. Critical value c0.01 = 2.576

 𝛽𝑡𝑎𝑛𝑔𝑖𝑏𝑙𝑒 ± 𝑐0.05 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑_𝑒𝑟𝑟𝑜𝑟
 -.065 ± 2.576*.018
 (-.111, -.019)

6. H0: 𝛽𝑠𝑖𝑧𝑒 = 0 against 𝐻1: 𝛽𝑠𝑖𝑧𝑒 > 0

0.012
𝑡 − 𝑟𝑎𝑡𝑖𝑜 = = 6, 𝑜𝑟 t = 4.13 from STATA output
0.002
At 1% significance level, c0.01=2.236 => t-ratio > c0.01 => reject the null
 Firm size has a positive impact on firm performance

7. H0: 𝛽𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛 = 0 against 𝐻1: 𝛽𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛 ≠ 0

𝑡 − 𝑟𝑎𝑡𝑖𝑜 = −4.80, 𝑐0.01 = 2.576
 |t-ratio| > 𝑐0.01 => reject the null => corruption have a significant effect on roe at 1%
significant level.

8. H0: 𝛽𝑙𝑒𝑣𝑒𝑟𝑎𝑔𝑒 = −0.2, H0: 𝛽𝑙𝑒𝑣𝑒𝑟𝑎𝑔𝑒 ≠ −0.2,

−.168 − (−0.2)
𝑡 − 𝑟𝑎𝑡𝑖𝑜 = = 1.18
. 027

Critical value: 𝑐0.05 = 1.96

 |t-ratio|< 𝑐0.05 => cannot reject the null

9. H0: 𝛽𝑡𝑎𝑛𝑔𝑖𝑏𝑙𝑒 = −1, H0: 𝛽𝑡𝑎𝑛𝑔𝑖𝑏𝑙𝑒 ≠ −1,

−.065 + 1
𝑡 − 𝑟𝑎𝑡𝑖𝑜 = = 51.94
. 018

Critical value: 𝑐0.05 = 1.96

 |t-ratio|> 𝑐0.05 => reject the null

10. Firm performance is positively affected by firm size, sales growth, financial freedom.
These effects are significant at 1%
Firm performance is negatively affected by firm leverage, tangible assets, corruption.
These effects are significant at 1%.
Firm age and board size have no significant impact on firm performance.

11. H0: 𝛽3 = 𝛽4 , H1: H0 is not true

 p-value <0.01 => reject the null at 1% significance level => 𝛽3 ≠ 𝛽4

12. H0: 𝛽3 = 𝛽4 = 𝛽5 = 𝛽6 = 0, H1: H0 is not true

p-value <0.01 => reject the null at 1% significance level => 𝛽3, 𝛽4, 𝛽5, 𝛽6 cannot equal
zero at the same time

13.

At 5% significance level, p-value > 0.05 => fail to reject the null hypothesis.

14. p-value=0.000 => reject H0 => all coefficients cannot equal zero at the same time.
 15.

Corr(financial freedom, corruption) =0.727 >0.7 => high collinearity between these variables.
Solve: drop one of them, and include uncorrelated variables.
16.
To eliminate missing observations.