The Measurement of Firms’ Efficiency Using Parametric Techniques

Abstract

In this chapter we summarize the main features of the standard econometric approach to measuring firms’ inefficiency. We provide guidance on the options that are available using the Stochastic Frontier Analysis (SFA), the most popular parametric frontier technique. We start this chapter summarizing the main results of production theory using the concept of distance function. Next, we outline the most popular estimation methods: maximum likelihood, method-of-moments and distribution-free approaches. In the last section we discuss more advance topics and extend the previous models. For instance, we examine how to control for observed environmental variables or endogeneity issues. We also outline several empirical strategies to control for unobserved heterogeneity in panel data settings or using latent class and spatial stochastic frontier models. The last topics examined are dynamic efficiency measurement, production risk and uncertainty, and the decomposition of Malmquist productivity indices.