Prediction Ability

Katsuya Takii

No 1411, Econometric Society World Congress 2000 Contributed Papers from Econometric Society

Abstract: This paper models managerial human capital as the ability to predict future events. My assignment model shows that a manager who has high prediction ability goes into a risky industry, because risk increases the marginal productivity of prediction ability. This conclusion contrasts with that of Lucas (1978). In Lucas's model talented managers simply manage bigger firms. The data supports my view: talented B-school graduates choose to work in risky industries, and the correlation between an ability measure and a risk measure is 0.75. The simulated assignment model fits B-school placement data quite well, and a 1 percent increase in the GMAT score of a B-school graduate implies a 158 percent increase in the risk of the firm to which the graduate is assigned. I also employ a dynamic analysis, which shows that prediction ability increases a firm's expected Tobin's Q and allows a firm to attain a higher expected growth rate. The COMPUSTAT dataset confirms these points as well.

Date: 2000-08-01
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