18 A M. McGahan and M. E. Porter of a spillover effect on the segment in year t. parent, or segment-specific. The error, ik, /, for By including industry-year interaction dummies, which we assume independence, is the portion of however, his model does capture spillovers that the transient shock that is not influenced by the ffect all the members of an industry. Now sup- shock in the prior year. This specification accom- pose that the business cycle generates unusually modates both new shocks and spillovers from the high year effects in successive years. Rumelt's prior year, although it cannot capture differences industry-year interaction term may partly capture in the rate at which shocks resound across years the influence of the business cycle, which would (Rumelt's model can capture differences in the be attributed to persistence in the year effect in rate of persistence in industry shocks ) We a complete model. Rumelt justified his approach acknowledge this deficiency, but argue tha y reporting no autocorrelation in residuals from changes in the rate of persistence are important his estimation. Nonetheless, this justification does in the second order whereas the simple presence not address the possibility that industry-year of persistence in year, corporate-parent and seg interaction effects may proxy for persistence in ment-specific shocks is important in the first year, corporate-parent, and business-specific order. As a result of this difference in spec effects in his specification. This possibility is ficati salient given that Rumelt's data cover the period only with the stable effects in Rumelt's work immediately subsequent to the 1973 oil shock It is important to note that a;, Bk, and i k and to the removal of wage and price controls describe how a business under the Nixon administration all years by its industry, corporate parent, and Although we appreciate the benefits of model- segment-specific situation. The rate of persistence, ing transient industry effects, we exclude them p, reflects the influence of a shock in any single because the model would be overspecified if we year on the performance in just the subsequent equally represented transient year effects, transi- year. To isolate the portions of effects that are ent corporate-parent effects, and transient busi- stable, we subtract from (1) the rate of persist ness-specific effects. This point is important to ence, p, multiplied by the lagged value of rik the differences in our econometric model com pared with Rumelt's In Rumelt's view, an asym- rik,=pr k -1+(1-p)u+Y-pYi-I treatment of industry effects is justifie when the data cover a relatively short period +(1-px1+(1-p)4+(1-p)dk because corporate-parent and business-specific ();k effects will not change much (i.e, when shocks are small so that the persistence of shocks The left-hand side of this equation is the same between years is not important ) However, transi- as in (1): it is the profit to business segment i, k ence may arise at any level, and it is at least at time t in percent. The first term on the right plausible that industry effects will change slower hand side is the rate of persistence multiplied by than business-specific or corporate-parent effects. the profit to the same business segment at time Indeed, in another paper (McGahan and Porter, t-1. In calculating lagged variables, we lose data 1997)based on the same data set but somewhat for the first year for which we have information different methods, we show that shocks to busi- on each segment. The other terms on the right ness-specific and corporate-parent effects may be hand side include the year, industry, corporate larger than industry shocks parent, and segment-specific effects To deal with the possibility that a shock in We analyze this model in two ways, following year t-I might influence profits in year I, we Schmalensee and Rumelt. First, we conduct a allow for serial correlation on the errors in components-of-variance(COV) estimation under uation I according to the following process: the assumption that random processes generate each of the effects in Equation 1. Consider, for ∈;k=p∈,k-1+①.k (3) This assumption is completely separate from our prior dis- The parameter p captures the intertemporal per- the technical assumptions by which we estimate the model cussion of stable and transient effects. Here, we are describe sistence of effects regardless of source: in Equation 4 given that the model includes only stable effects, macroeconomic fluctuations, industry, corporate- year effects, and the error. At this point, we are interested