What determines a firm's productivity? Financiers and economists have long speculated about the factors that explain the large and persistent differences in productivity across firms, even in narrowly defined industries.
Analyses of the U.S. manufacturing sector show that the most productive plants within an industry make almost twice as much output with the same measured inputs as least productive plants. Other studies have found even larger productivity differences in emerging markets such as China and India where the productivity differences can be over five times.
The traditional approach to analysing firm productivity differences using inputs, such as raw materials, capital, labour and technology, fails to explain a large part of the documented differences in firm productivity. Instead, we take a new approach to explain these productivity differences by measuring the human capital of entrepreneurs and workers as distinct inputs of production, and also taking into account the impact on productivity of the general level of human capital of the region where the firm is located. This approach allows us to directly analyse and compare the empirical contribution of the human capital of managers and workers to firm productivity for a large set of firms across countries and regions within countries. Specifically, we investigate the determinants of firm productivity using a newly constructed database of thousands of firms around the world. We combine the firm data with a set of regional geographic, institutional, cultural, and human capital variables that may also impact firm productivity in different sub-national regions in over 100 countries.
Econometric estimation and calibration show that both entrepreneurial education and externalities coming from the average level of human capital of the people in the region where the firm is located are critical factors explaining firm-level differences in factor productivity. Our estimates show that the contribution of managerial education of the top manager (i.e., CEO) to firm productivity is close to five times larger than the contribution of the education of the non-management workers of the firm. This evidence suggests that earlier estimates of return to education have largely missed one of its important benefits – entrepreneurship and manager’s education. The education of the CEO accounts for a large part of the previously unexplained differences in productivity across firms.
These results point most directly to the role of the supply of educated entrepreneurs for the creation and productivity of firms. The human capital of the entrepreneur is central in the creation of firm-specific competitive advantages. Firms may capitalise on this source of profitability through various channels. Educated CEOs may be better at organising production, managing firms, and adopting or developing new methods and technologies.
Managerial education also helps explain why not all firms are able to adopt established good operational, human resources, or managerial practices. Good firm policies may not be successfully adopted by all firms because these firms do not have or cannot afford high human capital CEOs. Highly-educated managers may be faster at adopting good policies because their human capital makes it less costly for them to implement such measures or because they are faster at learning how to implement them.
The business policy implication of our results is clear: the investment in the education of the manager is an essential component of the ability of the firm to reap the benefits of innovations and market opportunities. Educated managers may be better equipped to establish and implement more efficient internal managerial and incentives processes allowing their firms to profit from innovations and opportunities. The results also imply that investment in the education of high level managers of the firm the hiring of outside managers with high human capital may prove to be some of the most profitable firm policies as they translate into significant productivity enhancements. At the country level, improving management education may be a very attractive investment as it translates into more productive firms. These results should help guide family firms seeking to improve their efficiency, particularly when thinking about the long-term. The human capital of the second and third generations becomes a key factor to try to ensure the survival of the firm under family control.