Management Practices as a Proxy for Firm Quality

Abstract

This paper uses firm-level data on management practices to proxy for firm quality. To that end, we create portfolios comprised of well-managed and poorly-managed firms with the management practice score (a number between one and five) as our sole selection criteria. We find that: (1) Between 1999 and 2019, the well-managed portfolio consistently outperformed the poorly-managed portfolio with respect to profitability, investment, default risk, financial strength, and market capitalization; (2) In the period from 1999 to 2008, a portfolio that took a long position in stocks of well-managed firms and a short position in stocks of poorly-managed firms earned a monthly three-factor alpha of 0.89% (t=2.16) and a five-factor alpha of 1.14% (t=2.75).