This paper examines whether, why, and how managerial ability is associated with firms’ investment behavior. Specifically, we focus on the effect of managerial ability on extreme investment behavior. We define expansionary (contractionary) investments as investing significantly more (less) than what is expected based on the firm’s sales growth and industry membership. The baseline results reveal that more able managers are less likely to make contractionary investments, while they are more likely to make expansionary investments. We further propose and test the strategic investment hypothesis, which predicts that more able managers time the product markets and invest aggressively to ensure firms’ future competitiveness. The evidence is supportive of this hypothesis: More able managers are more (less) likely to make expansionary (contractionary) investments when the industry (1) becomes more competitive, and (2) is at the onset of R&D growth. Moreover, expansionary investments by more able managers are indeed their strategic investments, which lead to superior future abnormal returns.
Managerial Ability and Extreme Investment Behavior