Management Quality, Financial Policies, and Asymmetric Information
54 Pages Posted: 6 Mar 2007 Last revised: 16 Dec 2017
Date Written: November 1, 2006
We develop measures of the management quality of firms and make use of a unique sample of hand-collected data to examine the relationship between the reputation and quality of a firm's management and its financial policies, a relationship that has so far received little attention in the literature. We hypothesize that better and more reputable managers are able to convey the intrinsic value of their firm more credibly to outsiders, thus reducing the information asymmetry facing their firm in the equity market. Given this, firms with better and more reputable managements will have more access to the equity market, so that we expect lower leverage ratios for these firms. In addition, they will have less need to signal using dividends, so that they will have lower dividend payout ratios. Further, since better managers are likely to select better projects (having a larger NPV for any given scale) and implement them more ably, higher management quality will also be associated with higher levels of investment and R&D expenditures. We present evidence consistent with the above hypotheses. Our direct tests of the relationship between management quality and asymmetric information also indicate that higher management quality leads to a reduction in the extent of information asymmetry facing a firm in the equity market.
Keywords: Management Quality, Capital Structure, Dividend Policy, Investment Policy, Asymmetric Information
JEL Classification: G24, G31, G32, G35
Suggested Citation: Suggested Citation