Picking Winners: Managerial Ability and Capital Allocation in Internal Capital Markets
Final Report Abstract
Model-theoretical considerations and survey results among financial decision-makers suggest that top management’s decisions about resource allocation in internal capital markets are based on their assessment of the human capital (“managerial ability”) of division managers – the managers below the C-suite with direct responsibility for designing, monitoring and managing capital projects. However, in the existing empirical literature, which is typically based on the neoclassical setting of capital allocation (as a pure function of industry or firm-specific characteristics), the importance of heterogeneity in the human capital of divisional managers has not yet been explicitly examined. In the research project, a comprehensive empirical analysis was conducted to demonstrate for the first time that a positive, economically significant relationship exists between managerial ability and capital allocation. Thematically, the project connects the literature on internal capital markets and internal labor markets and includes a series of novel analyses that provide new insights into the economic mechanisms and implications of the positive relationship between human capital and capital allocation. Among other things, it shows that a more pronounced framework for the management and monitoring of the company (governance structures) has a positive effect on the sensitivity of capital allocation to the ability of division managers. It also provides evidence that favoring divisions with more able managers in capital allocation (“winner picking”) has a positive effect on company value and consequently increases the investment efficiency of companies. Possible endogeneity problems were addressed with a comprehensive series of robustness analyses, including the systematic appointment of particularly able division managers to divisions that are already strongly capitalized, as well as other types of sorting effects (“assortative matching”). The research project is based on a unique database for which 1,454 division managers were identified for a panel of S&P 1500 companies for the period 2000-2018 and their biographical information collected. For the empirical analysis, the project developed the DMA score, a new measure for quantifying the performance of division managers, which can be used to analyze heterogeneities in the human capital of this important group of executives.
Publications
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Picking Winners: Managerial Ability and Capital Allocation. SSRN Electronic Journal, 2023.
Benz, Andreas; Demerjian, Peter R.; Hoang, Daniel & Ruckes, Martin E.
