How Much are Differences in Managerial Ability Worth?
Posted: 7 Jul 1997
Date Written: March 1997
We attempt to measure how much differences in managerial ability can affect firms' values. If transaction costs or firm specific human capital prevent the firm and CEO from recontracting to the CEO's market wage, then the value of the firm will depend on the continued employment of the CEO. Applying Lazear's (1986) model of raids in the managerial labor market, we argue that only high ability executives are bid away by other firms. By comparing the abnormal returns associated with loss of an executive to another firm with those associated with loss of an executive by sudden death, we derive a measure of the relative contributions to the value of the firm (net of wages) of high vs. average ability managers. We find positive abnormal returns in response to sudden executive death and negative abnormal returns in response to top executives being bid away by another firm. In addition, we find a negative event response when an executive is bid away by a larger firm and a positive event response when managers leave for smaller firms. This finding is consistent with Rosen's (1982) hypothesis of a complementarity between firm size and managerial ability.
JEL Classification: J24, J41
Suggested Citation: Suggested Citation