Performance evaluation when non-discretionary factors correlate with technical efficiency

Abstract The current data envelopment analysis (DEA) literature on non-discretionary inputs ignores the possibility that efficiency may be correlated with the non-discretionary factors. This paper extends the literature by analyzing the effects that such correlation has. It will be shown that if the true technical efficiency is negatively correlated with the non-discretionary inputs, the existing DEA efficiency estimates will be biased upward. Using simulated data, the performance of the existing model will be analyzed. In addition, a corrected model will be introduced to effectively handle the problem. The resulting model is able to disentangle the two effects that the non-discretionary factor has on production.