Endogenous Differences

28 Nov

One common variety of empirical papers in finance uses staggered adoption of a policy to identify the impact of the policy on firms registered in the state, e.g., profits, etc. There are a host of problems with such empirical strategies, including, prominently, 1. policy adoption and timing are generally endogenous to firm activity within and across states and 2. it is hard to account for the impact of other policies that may have been adopted after a policy and may explain the outcomes. Recent econometric literature adds to the list of issues by pointing out a serious problem with using two-way fixed effects to analyze such data. I add to the pile. After the first state has adopted a policy, any firm registrations are endogenous to the policy environment—firms choose to locate (relocate) based on state policies. So when analyzing data from such a research design, we may want to fix the cohort of firms to firm-registration status to before the time the first state changed its policy and treat registration changes, etc., as non-compliance.