Technical Efficiency of Construction Companies: A Stochastic Frontier Model with Dependent Error

Abstract

There are several problems with using the Standard Stochastic Frontier (SF) model to produce a company’s technical efficiencies. One of the problem is the hypothesis of independence between the error components, known as, statistical noise and inefficiency term. Recent studies have used the SFA-copula model where the copula element captures the joint distribution of the two error components thus assuming that the errors are dependent. This research seeks to use the Cobb-Douglas Stochastic Frontier production model (standard model), SFA-copula models and DEA models (DEA-CCR and DEA-BCC) to compare the technical efficiencies of 12 publicly listed construction companies in Malaysia. The latter models are non-parametric frontier models which will be used as a base to determine the best SF model. The four copulas considered in this study are Clayton, Gumbel, A12 and Product copulas. The main findings of this study are the SFA-copula models showed consistency in terms efficiency scores and rankings of companies as compared to DEA models. The results further raise the question of the reliability of standard SF model especially when SFA-product copula was chosen as the best model for measuring efficiency performance. Therefore, it is obvious that it is not possible to ignore the reliance between the noise and inefficiency term