Question

Consider an equation to explain salaries of CEOs in terms of annual firm sales, return on equity (roe, in percentage points), and return on the firm’s stock (ros in percentage points):

log(salary) = β0 + β1 log(sales) + β2roe + β3ros + U.

Test the null hypothesis that roe has no effect on salary against the alternative that roe has a positive effect (after controlling for the other observables). Carry out the test on the 10% significance level. (Help to get the critical value: Φ−1(0.9) = 1.282, Φ−1(0.8) = 0.842, Φ−1(0.95) = 1.645.)

Would you include roe in a final model explaining CEO compensation in terms of firm performance? Explain.

Answer 1

1.​​​​​Ho : B_{​​​​​​3}= 0, H_{​​​​​​o} : B_{​​​​​​3} = 0