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Executive compensation has risen dramatically beyond the rising levels of an average worker's wage over the years. The government is even considering a cap on high-flying salaries for executives (The New York Times, February 9 , 2009). Consider the following portion of data which links total compensation (in dollar millions) of the highest-paid CEOs in with three measures: industry-adjusted return on assets (ROA), industry-adjusted stock return (Return) and the firm's size (Total Assets in dollar millions).
a. Estimate three simple linear regression models that use Compensation as the response variable with , Return, or Total Assets as the explanatory variable. Which model do you select? Explain.
b. Estimate multiple linear regression models that use various combinations of two, or all three, explanatory variables. Which model do you select? Explain.
Solution
VerifiedWe are given a sample of compensations, ROA , returns and total assets of companies.
Our goal is to estimate three simple linear regression models with compensation as the response variable and ROA, return and total assets as explanatory variables, respectively.
We can write these models as:
We also want to decide which one of these three models is the best.
How do we estimate these models?
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