Some implications of x-efficiency theory for the role of managerial quality as a key determinant of firm performance and productivity

The level of firm-level efficiency, thus performance and productivity, as a function of managerial quality is often ignored in neoclassical economics, which focuses on profit maximisation and assumes that firms are x-efficient, irrespective of how realistic this assumption is for underlying managerial quality and efficiency variables. The growing behavioural economics research in recent decades has yielded findings that are inconsistent with the neoclassical axioms of optimisation and profit maximisation by firm decision-makers. Applying Leibenstein’s x-efficiency theory, this chapter analyses the effect of managerial quality on the level of x-efficiency as a potential source of performance variations and persistent productivity growth gaps across firms and countries. The findings presented in this chapter support the core behavioural economics assumption that the realism of assumptions matters fundamentally to model building – in this case, the importance of management in firm performance and productivity. A critical point arising from the empirical results of this chapter is that human factors such as managerial quality (or managerial capital) and managers’ choices affect both employees’ efforts and overall firm performance and productivity growth by affecting the firm’s level of x-efficiency.