Handbook of Corporate Finance Empirical Corporate Finance Volume 1

Chapter 2

SELF-SELECTION MODELS IN CORPORATE FINANCE*

KAI LI
Sauder School of Business, University of British Columbia, 2053 Main Mall, Vancouver, BC,
V6T 1Z2 Canada
e-mail:[email protected]

NAGPURNANAND R. PRABHALA
Robert H. Smith School of Business, University of Maryland, College Park, MD 20742, USA
e-mail:[email protected]

Contents

Abstract 39
Keywords 39
Introduction 40
I. MODELING SELF-SELECTION 41

1. Self-selection: The statistical issue 42


2. The baseline Heckman selection model 42
   2.1. The econometric model 42
   2.2. Self-selection and private information 43
   2.2.1. Selection: An omitted variable problem 43
   2.2.2. The omitted variable as private information 44
   2.3. Specification issues 45
   2.3.1. Exclusion restrictions 45
   2.3.2. Bivariate normality 47


3. Extensions 47
   3.1. Switching regressions 47
   3.2. Simultaneity in self-selection models 49
   3.2.1. The Roy model 49
   3.2.2. Structural self-selection models 50

*We thank N.K. Chidambaran, Craig Doidge, Espen Eckbo, Andrew Karolyi, Gordon Phillips, Vojislav
Maksimovic, Jeffrey Smith, and Xinlei Zhao without implicating them for any errors or omissions, which re-
main ours. Li acknowledges the financial support from the Social Sciences and Humanities Research Council
of Canada, and the W.M. Young Chair in Finance from the Sauder School of Business at UBC. Li also wishes
to thank the support and hospitality of the MIT Sloan School of Management where she completed most of
her work on this chapter.

Handbook of Corporate Finance, Volume 1
Edited by B. Espen Eckbo
Copyright©2007 Elsevier B.V. All rights reserved
DOI: 10.1016/S1873-1503(06)01002-6