A population regression model is specified as

where Li is the leverage ratio of firm i, Si is the log of total sales of firm i for measuring firm size, M/Bi is the market value of equity divided by book value of equity of firm i, and EPSi is the earnings per share of firm i for measuring firm profitability.

Equation 1, as shown below, is the results from using ordinary least squares (OLS) regression estimation based on 100 firm observations:

The figures in parentheses below show the estimated standard errors for the coefficient estimates.

1.1) From Equation 1, determine whether there exists a statistically significant relation between the firm leverage ratio (L) and its market-to-book equity ratio (M/B). State a null hypothesis for a two-sided test and compute the t-statistic and p-value for your test for this hypothesis. What would you conclude using a significance level of 5%? Also explain the economic meaning of the test result of the slope coefficient 2 on the market-to-book equity ratio (M/B).

[12%] [maximum word count: 350]

1.2) Suppose that the theory predicts a positive relationship between the firm leverage ratio and its profitability (i.e., EPS). State a null hypothesis and compute the t-statistic and p-value for your test for this hypothesis. What would you conclude using a significance level of 5%? Also explain the economic meaning of the test result of the slope coefficient 3 on EPS.

[13%] [maximum word count: 350]

Continue overleaf.../

1.3) In the above regression estimation, a potential problem is the omitted viable bias. Critically explain and discuss the omitted viable bias, the consequences of this bias, and the conditions for this bias to occur in the regression context. Use words to explain in combination with some mathematics to illustrate your points.