In the case of profit function, total profit is specified as the net profit before tax. The
dependent variable in the model is determined as ln( ) . As a number of banks in the sample has
losses rather than profits, a constant , such as , is added to the profits of all firms to eliminate the
negative values 11.
Environmental Variables
To allow for the effect of country specific banking technology features, some country-specific
variables -several geographic, market structure as well as financial depth variables- are included into
the cost and profit estimation functions since they are assumed to be the major factors in explaining the differences in the cost and profit functions of the banks across countries 12 (Dietsch and Lozano - Vivas, 2000). Several empirical studies have emphasized the importance of environmental variables in
the efficiency estimates in banking literature (Allen and Rai, 199613; Dietsch and Lozano - Vivas, 2000; Lozano - Vivas et al., 2001; Lozano-Vivas et al., 2002).