The Relationship between External and Internal Performance Measures of the Firm: A Panel Cointegration Approach

Abstract

This article uses the recent developments in the econometrics of non-stationary dynamic panel data to re-examine the relationship between external and internal performance measures of the firm. A sample of 420 U.S. firms over the period (1990-2004) is used in the empirical analysis. In addition, four sub-samples are specially designed according to two contextual factors, namely, size of the firm and its life cycle. The panel unit root test of Im, Pesaran and Shin (2003) and the panel cointegration test of Pedroni (2004) were applied on the overall sample and on the four sub-samples to verify the existence of a long term equilibrium between market value added per share (MVA), which is the external performance measure, and four internal performance measures, namely, earnings per share (EPS), cash flow from operations per share (CFO), residual income per share (RI) and economic value added per share (EVA). Our main results show that the cointegration relationship between MVA and EVA is the most powerful, compared to the other models. Also, regardless of the firm-size factor and the firm’s life cycle factor we found the same results. Several explanations are provided for the above findings supported by a robustness analysis using panel error-correction models.

Keywords: corporate finance, non-stationary dynamic panel methods, performance measures, panel error-correction model

JEL Classification: G1, G3