Finance

JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS doi:10.1017/S0022109009990299

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 ∗

Abstract
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.

I.

Introduction

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

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