Systematic Departures from the Frontier: A Framework for the Analysis of Firm Inefficiency

Abstract

Departures from a production or cost frontier may reflect the systematic effect of conditions that contribute to inefficiency. To test whether some portion of frontier function departures can be systematically explained, the frontier inefficiency error component is modeled as a function of various causal factors and a random component. The functional form of the inefficiency error term model is chosen to assure strict one-sidedness. Preliminary empirical results generated from electric utility data suggest the superiority of including both systematic and random components in the inefficiency error term.