344 THE AMERICAN ECONOMIC REVIEW JUNE1985 light on the relative merits of at least the decomposed as follows extreme versions of the classical, revisionist and managerial positions. An extreme classi- (2 )02(r)=02(a)+o2(B)+r202(S) differ substantially with a =y=0 for al, o cist, for instance, would expect the B's a2()+2p(a,B)o(a)o(B) Estimates consistent with these expectations would of course not exclude the possibility +2yp(a, S)o(a)o(s) that industry effects simply reflect industry- wide differences between accounting and +2Yp(B,S)o(β)o(S) economic rates of return or industry-level disequilibria, with variations in monopoly where the p's are correlation coefficients and power of little or no importance. But a find- the as are standard deviations. Depending ing that the as and y did not differ signifi on which effects are revealed to exist by the cantly from zero would cast doubt on ex- analysis of (1),I estimate either (2)or a treme managerial or revisionist positions. special case thereof to provide information The implications of these last two posi- on the importance of the determinants of ons for the parameters of equation(1)are observed profitability. Estimates of (2)relate slightly less clear cut. An extreme revisionist directly to the predictions of the alternative would presumably expect a large y with all traditions discussed above. The particular the as and B's near zero if the r were (random effects) estimation techniques used observations on equilibrium rates of return. in this phase of the analysis are presented in But, since our data are in fact for a single Section Ill year and thus reflect the effects of cyclical In most of the statistical literature con- and other short-run industry-level disequi- cerned with variance decomposition, orthog libria, an extreme revisionist would not likely onality of effects is assumed, so that covari be surprised to find significant differences ance terms like the last three on the right of among the B's estimated here. Similarly, an (2) are set to zero. But that assumption is extreme managerial position might be that not plausible here. If an important attribute ariations in the a's should be much more of efficient firms is their ability to pick prof important in equilibrium than those in the itable industries in which to operate, for Bs or in the yS,, terms. But an extreme instance, we would expect this feature of the managerialist would also not likely be sur- data generation process on which I must rised to find differences in the Bs in a condition the estimates to produce a positiv single year's data. Moreover, firm-level p(a, B). Similarly, one expects efficient firm efficiency differences might affect business to have low costs and high shares, so that unit profitability through the revisionist p(a, S)should be positive. Finally, if one mechanism, so that firm-level and share knows that some particular Sii is above aver- effects might be hard to distinguish. (I in- age, one's conditional expectation must be vestigate this possibility below.) that concentration in market j is above aver Using firm and industry dummy variables, age. If one expects industry concentration to I first use ordinary least squares(fixed effects be positively related to industry profitability, estimation)and the usual F-statistics to test it then follows that one expects p(B, S)to be for the existence of market effects(noniden- positive. On the other hand, since e captures tical B's), firm effects(nonidentical as), and all profitability differences unrelated to firm, share effects (nonzero y )in(1)and the natu- industry, or market share diffe erences ral special cases thereof. To analyze the im- assumption that it is orthogonal to those portance of these effects, I treat the actual effects seems natural and reasonable ' s, B's, S's, and es in any particular sam- The strength of this descriptive approach ple as(unobservable)realizations of random is that my conclusions about the three rele- variables with some joint population distri- vant types of effects will not be conditioned bution. Under the usual assumption that e is distributed independently of the other vari- ables, the population variance of r can be See. for instance, S.R. Searle(1971, chs 9-11)