Purpose – Quantifying managerial ability is central to management literature. Prior research indicates that manager specific features (ability, talent, reputation, or style) affect economic outcomes and are therefore important to economics, finance, accounting, management and IC research as well as to practice. Most of the measures used in archival research, also reflect significant aspects of the firm that are outside of management’s control. The paper, coherently with Demerijan et al. (2012), is directed to exploit the possibility to measure the managerial ability assessing managers based on the efficiency with which they generate revenues.
Design/methodology/approach – The paper addresses his aims applying a more sophisticated approach to the three stage estimation (Fried et al., 2002), in which both Data Envelopment Analysis (DEA) and Stochastic Frontier Approach (SFA) are used to estimate the efficiency scores firms to derive a measure of manager ability (MA). The method used could be named “two-stage SFA DEA” approach. Our idea is to obtain a measure of MA as residue of the inefficiency equation of SFA and to use it as a new input to insert in the “second/third” DEA stage. The Italian banks have been chosen as the sample to investigate and implement our model.
Originality/value – The originality of the paper consists in the proposition of a new model to measure managerial ability, able to outperform the alternative measures of managerial ability, simple to use as it is based on easily obtainable financial data and available for a broad cross section of firms. Moreover, our paper is original also from a technical point of view, by employing not just the SFA or DEA methodology, but a “two stage DEA SFA” approach, in which the frontier and the inefficiency equation are estimated simultaneously.
Practical implications – We believe that our managerial ability score exhibits an economically significant manager-specific component and contains less noise than existing proxies of managerial ability. This more precise measure of ability opens the door to a wide array of studies that previously were difficult to conduct.
Keywords – Managerial ability, Data Envelopment analysis (DEA), Stochastic Frontier Approach (SFA), “two-stage SFA DEA” approach