A statistical foundation for the measurement of managerial ability

Demerjian, Lev, and McVay (2012) (DLM) provide a conceptual framework for the measurement of managerial ability using data envelopment analysis (DEA). We show that the DLM method provides a consistent estimator of managerial ability. The DLM approach to measuring managerial ability begins with the first stage estimation of firm efficiency in transforming inputs into outputs. The second stage removes the impact of contextual variables on the firm efficiency so that the residuals measure the impact of unobserved managerial ability. We leverage the properties of the DEA estimator (Banker and Natarajan 2008) to show that the DLM approach provides a statistically consistent estimator of the managerial ability’s impact on firm efficiency.