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

• DOI: http://doi.org/10.1111/corg.12233
• Author: Isabel‐María García‐Sánchez,Emma García‐Meca
• Published date: 01 July 2018
• Date: 01 July 2018

ORIGINAL MANUSCRIPT

Do talented managers invest more efficiently? The moderating

role of corporate governance mechanisms

Isabel‐María García‐Sánchez

1

|Emma García‐Meca

2

1

Business Faculty, Accounting and Finance

Department, University of Salamanca, Spain

2

Technical University of Cartagena, Business

Faculty, Accounting and Finance Department,

Calle Real 3, 30201 Cartagena, Spain

Correspondence

Emma García‐Meca, Technical University of

Cartagena, Business Faculty, Accounting and

Finance Department, Calle Real 3, 30201,

Cartagena, Spain.

Email: emma.garcia@upct.es

Funding information

Spanish Ministry of Economy, Industry and

Competitiveness (Ministerio de Economía,

Industria y Competitividad)

Abstract

Manuscript type: Empirical

Research question/issue: The main objective of this paper is to examine the influ-

ence 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 econom-

ically relevant determinant of investment efficiency, resulting in lower levels of under-

investment 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 complemen-

tary measures to constrain inefficient investment decisions. The results also indicate

that the advantages of having able managers are especially noticeable during a finan-

cial crisis and under conditions of greater information asymmetry.

Theoretical/academic implications: Our findings suggest that governance mecha-

nisms are effective complementary measures to constrain inefficient investment deci-

sions. 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 deter-

minant 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 corpo-

rate governance mechanisms, implying that regulators should be aware of the rele-

vance of investor protection, legal enforcement, and board effectiveness to improve

the benefits of managerial attributes and therefore the financial efficiency of firms.

Received: 27 April 2017 Revised: 16 January 2018 Accepted: 28 January 2018

DOI: 10.1111/corg.12233

238 © 2018 John Wiley & Sons Ltd Corp Govern Int Rev. 2018;26:238–254.wileyonlinelibrary.com/journal/corg

KEYWORDS

Board‐Level Governance Outcomes, Board Task Effectiveness, Corporate Governance, Resource‐

Based Theory, Stewardship Theory

1|INTRODUCTION

The main objective of this paper is to examine the influence of mana-

gerial ability on investment efficiency. Some management theories

(e.g. the upper‐echelons theory; resource dependence) suggest that

individual differences in personal styles, skills, and business knowledge

can lead managers to make different choices that affect corporate

decisions (Hambrick & Mason, 1984). Inspired by the seminal paper

of Bertrand and Schoar (2003), recent research shows that managerial

ability effects earnings quality (Demerjian, Lev, Lewis, & McVay,

2013), voluntary disclosure (Bamber, Jiang, & Wang, 2010), and risk

taking (Andreou, Philip, & Robejsek, 2015).

Among the most important corporate decisions that managers can

make are those related to their financial investments. The efficiency in

the allocation of capital affects the growth and productive capacity in

the economy, so the study of their determinants is a key field of

research (O'Toole, Morgenroth, & Ha, 2015). The traditional literature

identifies a significant number of variables explaining investment effi-

ciency and variation in capital structure, such as firm, industry, and

market variables (Myers & Majluf, 1984). Idiosyncratic managerial

attributes are also considered to be relevant determinants of firm effi-

ciency in practice. According to Hermalin and Weisbach (2017), prac-

titioners, such as financial analysts or suppliers of finance, are

continually assessing the “quality of the managers”, because, even if

they have the best of intentions, their incompetence affects investors.

Although the role of individual managerial behavior in corporate

investment practices has been less widely researched, we predict that,

as able managers are perceived to have better knowledge and skill sets

and they should provide more accurate valuations of future payoffs

(Gan, 2015), they prevent firms from adopting under‐and overinvest-

ment policies. Therefore, as a primary objective, we test whether able

managers play a relevant role in achieving efficient corporate

investment behavior, examining whether their superior abilities, skills,

and knowledge lead them to make their investments closer to the

optimal levels.

Additionally, because corporate governance mechanisms contrib-

ute to reducing the expropriation of minority shareholders by better

aligning the interests of managers and shareholders (Leuz, Nanda, &

Wysocki, 2003), we expect managerial ability to perform more

effectively in countries with better internal and external governance

mechanisms. According to Fama and Jensen (1983), an effective board

of directors is better at monitoring and controlling manager behavior,

which can reduce agency costs and improve contracting efficiency.

Similarly, in countries with greater protection of shareholders' rights

and stronger institutions with greater enforcement, managers are

less able to expropriate shareholders (lower agency costs), have access

to more financial resources, and are more able to invest in projects

that benefit them (Ang, Cheng, & Wu, 2014; Bekaert, Harvey, &

Lundblad, 2011). In this regard, and as the second goal of this

research, we predict that the impact of managerial ability on invest-

ment efficiency is reinforced in countries with better corporate gover-

nance mechanisms.

Using a sample of 2185 firms from 24 countries for the period

2006–2015, we hypothesize a positive association between invest-

ment 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 gover-

nance mechanisms and managerial ability, testing the moderating role

of board effectiveness, the level of investor and creditor protection,

and the level of enforcement in the country. In line with previous stud-

ies, we measure investment efficiency using the measure proposed by

Biddle, Hilary, and Verdi (2009). Regarding the proxy for managerial

ability, we follow Demerjian, Lev, and McVay (2012) to estimate

how efficiently managers use their firms' resources. Robustness tests

with alternative measures are also provided.

Our results show that managerial ability is an economically rele-

vant determinant of investment efficiency, resulting in lower levels

of under‐and overinvestment. The economic impact of managerial

ability on investment efficiency is meaningful, showing that increasing

managerial ability by one standard deviation decreases investment

among firms that are overinvesting by approximately 79%. Addition-

ally, our findings note that the benefits of able managers for invest-

ment efficiency are reinforced when companies are located in

countries with better board effectiveness, superior investor protec-

tion, and better legal enforcement, suggesting that governance mech-

anisms 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 man-

agers have on investment efficiency. These results are robust to alter-

native measures of managerial ability and investment efficiency.

As an extension of the research, we investigate whether the ben-

efits of able managers remain in times of high uncertainty, when

agency problems are more likely to appear. We predict that managerial

ability helps to alleviate the over‐and underinvestment situations that

affect firms under more adverse selection and moral hazard problems

due to the greater ability of talented managers to reduce the informa-

tion gap and to access financial resources. As proxies for uncertainty

we use information asymmetry and crisis time. Our findings indicate

that the effect of managerial ability on firm investment efficiency

and the moderating role of the governance mechanisms are stronger

in the above situations, confirming that managerial ability is a signifi-

cant driver of investment efficiency, especially when companies face

higher levels of information asymmetry and less favorable conditions.

This study makes several contributions to the literature. First, it

supports the previous literature on managerial ability (Bertrand &

Schoar, 2003; Demerjian et al., 2013) and extends the emerging

GARCÍA‐SÁNCHEZ AND GARCÍA‐MECA 239