Data envelopment analysis for scale elasticity measurement in the stochastic case: with an application to Indian banking

Abstract

In the nonparametric data envelopment analysis literature, scale elasticity is evaluated in two alternative ways: using either the technical efficiency model or the cost efficiency model. This evaluation becomes problematic in several situations, for example (a) when input proportions change in the long run, (b) when inputs are heterogeneous, and (c) when firms face ex-ante price uncertainty in making their production decisions. To address these situations, a scale elasticity evaluation was performed using a value-based cost efficiency model. However, this alternative value-based scale elasticity evaluation is sensitive to the uncertainty and variability underlying input and output data. Therefore, in this study, we introduce a stochastic cost-efficiency model based on chance-constrained programming to develop a value-based measure of the scale elasticity of firms facing data uncertainty. An illustrative empirical application to the Indian banking industry comprising 71 banks for eight years (1998–2005) was made to compare inferences about their efficiency and scale properties. The key findings are as follows: First, both the deterministic model and our proposed stochastic model yield distinctly different results concerning the efficiency and scale elasticity scores at various tolerance levels of chance constraints. However, both models yield the same results at a tolerance level of 0.5, implying that the deterministic model is a special case of the stochastic model in that it reveals the same efficiency and returns to scale characterizations of banks. Second, the stochastic model generates higher efficiency scores for inefficient banks than its deterministic counterpart. Third, public banks exhibit higher efficiency than private and foreign banks. Finally, public and old private banks mostly exhibit either decreasing or constant returns to scale, whereas foreign and new private banks experience either increasing or decreasing returns to scale. Although the application of our proposed stochastic model is illustrative, it can be potentially applied to all firms in the information and distribution-intensive industry with high fixed costs, which have ample potential for reaping scale and scope benefits.