Unobservable effects in structural models of business performance

Critiques of the concept of key success factors have raised objections both conceptually and methodologically. From the latter perspective, common research practice is criticized for neglecting the influence of firm-specific, unobservable variables (e.g., management skills). To control for these effects, a structural equation approach ("LISREL") to the analysis of panel data is proposed. In an empirical study based on the PIMS annual database, the influence of unobservables on the direct and indirect effects of product quality on profitability is examined. It is shown, how a step-by-step extension of a basic simultaneous equation model sheds some light on the role unobservable variables play. Even after controlling for persistent unobservable effects, product quality and market share remain significant determinants of profitability. (C) 2002 Elsevier Inc. All rights reserved.