From the discussion of the comparative statics of managerial effort in Section
2.2 we know that managerial effort increases with an exogenous variable if and
only if increases in effort reduce the marginal cost of the variable. We have
defined all the arguments in C except a to have a positive marginal cost and the
cost function we estimate in Section 3 is multiplicatively separable Ž Ž . Ž .. Csf xua
between effort and its other arguments. This implies, in terms of Eq. 23 , that Ž .
d )0, but that d -0 and a )0, so that the estimated coefficient on x might 1 31 1
even have the wrong sign if the direct effect of x1 on costs is more than offset by
the cost reduction caused by the induced increase in effort. However, we can show
that the net effect of an increase in the non-effort arguments is to increase costs
provided only that ln u a is convex. This is satisfied by u aŽ. Ž . sexp ya which
is implicitly assumed in attempts to estimate AefficiencyB in terms of the residuals
or area specific dummies with logarithmic cost functions. Thus endogeneity of
effort will not lead to incorrect signs on the coefficients of exogenous variables,
though it may bias them towards zero.