Human Capital, Management Quality, and Firm Performance
65 Pages Posted: 20 Mar 2014 Last revised: 1 Dec 2018
Date Written: May 6, 2014
We analyze the relationship between the human capital of firms' top management teams (“management quality”) and their long-run performance using panel data from the BoardEx database on firms’ top management characteristics and a management quality index constructed using common factor analysis on individual proxies for various aspects of top management quality. We control for the potentially endogenous matching between firm and management quality using a plausibly exogenous shock to the supply of new managers as an instrument. Using this instrument, we find a causal relationship between firms' management quality and their future operating performance, market valuations, and stock returns. To further identify the relationship between management quality and firm performance, we make use of the differences in the frictions to the movement of top managers across firms located in various US states due to their differential adoption of the Inevitable Disclosure Doctrine (IDD). We hypothesize that the adoption of the IDD will reduce managerial incentives to exert effort on behalf of their firms. Consistent with this hypothesis, we find that the sensitivity of firm performance to management quality is lower in states that have adopted the IDD. Finally, we analyze the channels through which management quality may affect firm performance and find a positive relationship between management quality and firm investment (both levels and changes) as well as between management quality and new product introductions in the immediate future.
Keywords: Human Capital; Management Quality; Operating Performance; Market Valuation; Stock Return
JEL Classification: G32; L25
Suggested Citation: Suggested Citation