A critical assessment of the two-way fixed-effects model for firm-level dependent variables

Johannes Carow ()
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Johannes Carow: Johannes Gutenberg University Mainz

No 2405, Working Papers from Gutenberg School of Management and Economics, Johannes Gutenberg-Universität Mainz

Abstract: Since the seminal work from Bertrand & Schoar (2003), the separate estimation of person effects and firm effects remains a widely used method in the analysis of firm-level dependent variables. Recently, this class of models has experienced serious methodological criticism, stating that person effects only reflect spurious variation. Rather than rejecting this estimation technique per se, I recommend a strategy based on simulation analysis to test for the presence of person effects. This strategy takes limitations of a previous test for idiosyncratic person effects into account. Further, I show that the estimation of person effects is subject to attenuation bias and that the size of this bias increases in the number of persons per firm-year. I also demonstrate that the use of Unconditional Quantile Regressions for estimated person effects can produce statistical artefacts at the upper and lower tail of the distribution. Additionally, attenuation bias impairs the analysis of the correlation of person effects pertaining to different dependent variables.

Keywords: Two-way fixed-effects; simulations; managers; spurious variation; attenuation bias (search for similar items in EconPapers)
JEL-codes: C15 C18 C21 L25 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2024-03-18
New Economics Papers: this item is included in nep-dcm and nep-ecm
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