The Ratio Problem

32 Pages Posted: 15 Jun 2020

See all articles by Robert P. Bartlett

Robert P. Bartlett

University of California, Berkeley - School of Law; University of California, Berkeley - Berkeley Center for Law, Business and the Economy

Frank Partnoy

University of California, Berkeley - School of Law

Date Written: May 1, 2020

Abstract

We use the term "ratio problem" to describe the omitted variable and measurement error bias that can arise when a ratio is the dependent variable in an economic model. First, we show how bias can arise from the omission of two classes of variables based on a ratio's denominator. As an example, we demonstrate that the widely-cited "inverse-U" relationship between managerial ownership and Tobin's Q is reversed when these variables are included. Second, we show how measurement error in the ratio's denominator can produce bias. We provide empirical tests and solutions, and urge caution about ratios as dependent variables.

Keywords: Omitted Variable Bias, Measurement Error, Tobin's Q, Corporate Governance

JEL Classification: C01, C13, C58, G30, G34

Suggested Citation

Bartlett, Robert P. and Partnoy, Frank, The Ratio Problem (May 1, 2020). Available at SSRN: https://ssrn.com/abstract=3605606 or http://dx.doi.org/10.2139/ssrn.3605606

Robert P. Bartlett (Contact Author)

University of California, Berkeley - School of Law ( email )

215 Boalt Hall
Berkeley, CA 94720-7200
United States
510-642-6646 (Phone)

University of California, Berkeley - Berkeley Center for Law, Business and the Economy

UC Berkeley School of Law
Berkeley, CA 94720

Frank Partnoy

University of California, Berkeley - School of Law ( email )

215 Boalt Hall
Berkeley, CA 94720-7200
United States

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