A new panel unit root by Chang ( Journal of Econometrics , 110 , 261-92, 2002) is employed on a set of financial ratios with a view to improving the power of unit root tests when applied to a relatively small number of observations (in the present case 38 annual observations). The test is innovative in that it allows for cross-sectional dependencies and the asymptotic distribution of the test is standard. Although standard Dickey-Fuller tests suggest that individual financial ratio series are nonstationary, panel unit root tests strongly reject the null hypothesis of a joint unit root in the ratios. Taken together the evidence from the proposed new analysis implies strong persistence in the ratios but that their characterization as I (1) processes may be misleading. These findings have important implications for accounting and finance researchers who employ financial ratios as explanatory variables.
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