output from a certain bundle of inputs with given technology. The concept of efficiency was in-
troduced by Farrell (1957), who used the concept proposed by Koopmans (1951) and the radial
type of efficiency measure considered by Debreu (1951). In this paper, we test five hypotheses
on the determinants of efficiency differences across manufacturing firms in Germany during
1992-2005.
Hypothesis 1 Industry affiliation explains a large proportion of the differences in productive
efficiencies across firms.
Industry affiliation refers to the main business activity of a firm. In the literature, it is of-
ten assumed that industry affiliation can be used as a proxy for the relevant product market
(e.g., Schmalensee, 1985; Wernerfelt and Montgomery, 1988). If industry affiliation is related
to the product market, it should indicate the degree of competition a firm faces. Therefore, in
industries with intense competition, we hypothesize that average efficiency will be higher, as
inefficient firms are forced by competitive pressure to leave the market. The firm’s industry
affiliation can also be interpreted as describing the unobserved characteristics of the production
technology employed and of the product markets where the firms operate. Additionally, accord-
ing to Klepper (1997) and Klepper and Simons (2005), the efficiency of an industry depends on
its stage in the industry lifecycle.
Hypothesis 2 Firm location is important in explaining firms’ productive efficiencies.
A firm’s location influences its efficiency in several ways. For example, Beeson and Husted
(1989) found that in the United States, a considerable part of the variation of efficiency can be
attributed to regional differences of the labor force characteristics, levels of urbanization, and
industry structure. Second, the firm’s location may affect its innovation activities, with con-
sequences for its production process and efficiency (for an overview, see Cooke, Heidenreich
and Braczyk, 2004). Furthermore, the effect of locational conditions on efficiency is partly em-
bedded in knowledge spillovers (Krugman, 1991; Antonelli, 2003). Third, spatial proximity to
other establishments, as occurs in an agglomeration or a cluster, may be conducive to economic
performance for a number of reasons, including, for example, rich and diversified input markets
(Baptista and Swann, 1998; Porter, 1998, 2003).
Hypothesis 3 Efficiency is positively related to firm size.
From a theoretical viewpoint, the relationship between firm size and efficiency is not clear-
cut (Audretsch, 1999). On the one hand, larger firms have better market penetration and are
better able to exploit economies of scale and scope. Larger firms also have more money and
are able to employ better managers (Kumar, 2003). On the other hand, it is more difficult to
keep all departments coordinated and operating efficiently in a large firm (Leibenstein, 1966). In