Is there a dark side of managerial ability? Evidence from the use of derivatives and firm risk in China

In the absence of agency problems, firms with able managers are expected to use derivatives effectively for risk management purposes. But the agency theory suggests that self-interested managers may use derivatives to their advantage for rent-seeking activities. Using a sample of Chinese listed firms from 2008 to 2019, we find strong evidence consistent with this rent-seeking idea. In particular, we find that the relationship between the use of derivatives and firm risk is negative, but this negative relationship is less pronounced for firms with high-ability managers compared to firms with low-ability managers, suggesting that managerial ability has a positive moderating effect on this negative relationship. In addition, this positive moderating effect is more (less) pronounced in firms with weak (strong) monitoring, diffuse (concentrated) ownership, high (low) information asymmetry, and weak (strong) corporate governance. The findings are robust to alternative measures of key variables, an alternative empirical model, and endogeneity concerns. Consistent with the view that able managers’ rent-seeking activities (through taking risky derivatives position(s)) cannot enhance firm value or growth, further analyses reveal that both managerial ability and its interaction with the use of derivatives, have negative impacts on Tobin’s Q.