ABSTRACT
In this chapter, the authors provide an intuitive introduction to the two popular concepts of fixed effects regressions and clustered standard errors. They focus on a classical panel regression common to the corporate finance literature: firm investment modeled as a function that increases in firm cash flow and firm investment opportunities. The authors demonstrate that the regression based on annual data yields qualitatively similar results to estimations based on quarterly data from the literature, namely confirming the positive relationships between investment and the two regressors. The regression output shows a lot of unexplained variation at the firm level that is taken care of by including the firm fixed effect as the adjusted R-squared rises above 50%. The inclusion of time fixed effects did only marginally affect the R-squared and the coefficients, which the developers can interpret as a good thing as it indicates that the coefficients are not driven by an omitted variable that varies over time.
