Managerial Ability, Investment Efficiency and Stock Price Crash Risk

Abstract

This paper examines empirically the effect of managerial ability on firm-level investment efficiency, and the joint effect of managerial ability and financial reporting quality on stock price crash risk conditional on level of investment. Using a managerial ability measure developed by Demerjian et al. (2012), the paper documents consistent evidence that the more able managers over-invest compared to their not-so-able counterparts, even after controlling for the effects of financial reporting quality and other firm specific determinants of investment efficiency. This evidence is robust to alternative proxies for investment efficiency and financial reporting quality. The empirical evidence also suggests that crash risk increases for firms with talented managers, primarily because of an adverse effect of managerial talent on financial reporting quality (both accruals and real earnings management) and this effect is more pronounced for firms that over-invest. Overall, the study contributes to a better understanding of the influence of managerial ability on investment decisions and financial reporting quality in the context of diverging opinions regarding manager-specific effects on organizational outcomes.