Vol. 44, No. 5, Oct. 2009, pp. 1045–1079
COPYRIGHT 2009, MICHAEL G. FOSTER SCHOOL OF BUSINESS, UNIVERSITY OF WASHINGTON, SEATTLE, WA 98195
Management Quality, Financial and Investment Policies, and Asymmetric Information Thomas J. Chemmanur, Imants Paeglis, and Karen Simonyan ∗
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 and investment 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 managers 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 net present value (NPV) for any given scale) and to implement them more ably, higher management quality will also be associated with higher levels of investment. 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.
The determinants of the ﬁnancial policies of a ﬁrm have been the subject of considerable debate in recent times (see Welch (2004) for a recent example). Surprisingly, almost 50 years after the seminal papers by Modigliani and Miller on the capital structure and the dividend policy of a ﬁrm (see Modigliani and Miller (1958), Miller and Modigliani (1961)) and the extensive academic literature in ∗ Chemmanur, email@example.com, Boston College, Carroll School of Management, 440 Fulton Hall, Chestnut Hill, MA 02467; Paeglis, firstname.lastname@example.org, Concordia University, John Molson School of Business, 1455 de Maisonneuve Boulevard West, Montreal, Quebec H3G 1M8, Canada; Simonyan, email@example.com, Suffolk University, Sawyer Business School, 8 Ashburton Place, Boston, MA 02108. For helpful comments or discussions, we thank Mark Liu, Debarshi Nandy, Evgenia Portniaguina, Antoinette Schoar, Susan Shu, and Hassan Tehranian, seminar participants at Boston College, as well as conference participants at the 2005 American Finance Association Meetings, the 2007 European Finance Association Meetings, and the 2004 Financial Management Association Meetings. Special thanks to an anonymous referee and Hendrik Bessembinder (the editor) for various helpful comments that signiﬁcantly improved the paper. We also thank Sandra Caraballo for research assistance. Chemmanur acknowledges ﬁnancial support from a Boston College Research Incentive Grant.
Journal of Financial and Quantitative Analysis
corporate ﬁnance subsequent to their work, there is little agreement in the ﬁnance literature regarding the determinants of a ﬁrm’s ﬁnancial policies. Further, it is often acknowledged that several dimensions determining a ﬁrm’s ﬁnancial and investment policies may not have been analyzed in the literature (see, e.g., Gompers, Ishii, and Metrick (2004)). One “missing” factor that may be important in determining a ﬁrm’s ﬁnancial and investment policies is the quality and reputation of its management team. For example, the quality of a ﬁrm’s management has been widely regarded by practitioners (like venture capitalists and ﬁnancial analysts) as an important measure of ﬁrm quality and a predictor of its future performance....