Do talented managers invest more efficiently? The moderating role of corporate governance mechanisms

Abstract

Manuscript type Empirical Research question/issue The main objective of this paper is to examine the influence of managerial ability on investment efficiency. Using a sample of 2185 firms from 24 countries for the period 2006–2015, we hypothesize a positive association between investment efficiency and managerial ability and suggest that able managers make fewer over‐ and underinvestment decisions. As a unique and helpful feature of this study, we also employ a model to capture the different interactions between internal and external corporate governance mechanisms and managerial ability. Research findings/insights Our results show that managerial ability is an economically relevant determinant of investment efficiency, resulting in lower levels of underinvestment and overinvestment. Additionally, our findings note that the benefits of able managers for investment efficiency are reinforced when companies are located in countries with better board effectiveness, superior investor protection, and better legal enforcement, suggesting that governance mechanisms are effective complementary measures to constrain inefficient investment decisions. The results also indicate that the advantages of having able managers are especially noticeable during a financial crisis and under conditions of greater information asymmetry. Theoretical/academic implications Our findings suggest that governance mechanisms are effective complementary measures to constrain inefficient investment decisions. Specifically, our results highlight the relevance of the monitoring role of the board, noting that the efficiency of this internal control mechanism complements the effect that able managers have on investment efficiency. Practitioner/policy implications The paper has relevant implications. First, boards of directors must be aware that, although the access to financial resources is a determinant of firms' financial success, the individual ability to manage them is essential in making efficient investment decisions, which should be considered when recruiting new managers and establishing compensation schemes. Second, the paper shows that managerial ability is reinforced when the company is in a country with strong corporate governance mechanisms, implying that regulators should be aware of the relevance of investor protection, legal enforcement, and board effectiveness to improve the benefits of managerial attributes and therefore the financial efficiency of firms.

Tax Avoidance, Managerial Ability, and Investment Efficiency

“…We show that firms with higher (lower) managerial ability exhibit smaller (greater) deviations from predicted investments as tax avoidance increases. In this respect, we extend the work of Garcia‐Sanchez and Garcia‐Meca (), who show, using cross‐country data, that managerial ability is an important determinant of investment efficiency. Our contribution stems from focusing on funds generated through tax avoidance activities and showing that the relation between corporate tax avoidance and investment efficiency is conditional on managerial ability.…”

“…() argues that more able managers can better gauge the timing and magnitude of economic returns from investments, as well as better assess the risks and returns associated with investments. Consistent with this argument, Garcia‐Sanchez and Garcia‐Meca () find that managerial ability is an important determinant of investment efficiency, resulting in lower levels of under‐ or over‐investment. To the extent that funds generated through tax avoidance activities are an important source of capital, especially for financially constrained firms (Edwards et al ., ), we expect that compared to managers with lower ability, managers with higher ability use the proceeds from increased levels of tax avoidance to improve investment efficiency.…”

“…() measure of managerial ability as our primary conditioning variable of interest to identify firms more likely to use (or refrain from using) the proceeds from increased levels of tax avoidance to increase investment efficiency. Using cross‐country data, Garcia‐Sanchez and Garcia‐Meca () find that firms with higher managerial ability based on the Demerjian et al . () measure generally display higher levels of investment efficiency.…”

Share Centralization, Investor Sentiment and Firm Performance

“…In addition, Agrawal and Cooper [19] oppositely showed that bad governance mechanisms would follow accounting scandals. Garcia-Sanchez and Garcia-Meca [20] further argued that governance mechanisms are effective to cover inefficient investment decisions. At the last, Horstmeyer [21] studied internal monitoring as the internal governance concerns.…”

Managerial Ability and Firm Performance: A Labour Management Perspective.

“…Introduction of the managerial ability measure by Demerjian et al (2012) spawned a new literature examining how managerial ability affects various aspects of managers' decision-making. These studies have documented that managerial ability has a distinctive effect on a firm's financial reporting quality and earnings quality (Demerjian et al, 2013;Huang & Sun, 2017;Wang, Chen, Chin, & Zheng, 2017), earnings management activities (Skousen, Sun, & Wu, 2019), accounting and disclosure policies (Abernathy et al, 2018;Baik et al, 2011;Luo & Zhou, 2017;Sun, 2016), information environment (Baik et al, 2018), tax avoidance behaviour (Koester, Shevlin, & Wangerin, 2017), investment practices (Andreou et al, 2017;Gan, 2019;García-Sánchez & García-Meca, 2018;Habib & Hasan, 2017;Lee et al, 2018), risk-taking behaviour (Andreou et al, 2016;Yung & Chen, 2018), innovation activities (Y. Chen, Podolski, & Veeraraghavan, 2015), credit ratings (Bonsall, Holzman, & Miller, 2017;Cornaggia, Krishnan, & Wang, 2017), structure and pricing of debt (Bui, Chen, Hasan, & Lin, 2018;De Franco, Hope, & Lu, 2017;Petkevich & Prevost, 2018), dividend policies (Guan, Li, & Ma, 2018;Jiraporn, Leelalai, & Tong, 2016); audit fees (Gul, Khedmati, Lim, & Navissi, 2018;Li & Luo, 2017); firm performance (Banker, Darrough, Huang, & Plehn-Dujowich, 2013;Cox, 2017;Demerjian et al, 2012;Francis, Hasan, Mani, & Ye, 2016), and corporate social responsibility (CSR) performance …”