Abstract

Introduction

Literature review and hypotheses development

Methodology and data

Empirical results

Conclusion

Research implications

Availability of data and materials

References

Acknowledgements

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Abstract

This study utilizes mediation analysis and bootstrapping to analyze the mediating effect of capital structure on the association between managerial ability and firm performance. The dataset consists of 6384 firm-year observations from the Taiwanese electronics industry during 2005–2018. Our results indicate that (1) low (high) levels of debt are likely observed in firms with CEOs with high (low) ability, (2) managerial ability positively affects firm performance, and (3) capital structure mediates the positive relationship between managerial ability and firm performance. Overall, the findings may have limited generalizability due to the specific sample characteristics and provide convincing support for the importance of capital structure as a mediator in the managerial ability-firm performance nexus. Specifically, this study highlights the need for examining the effect of managerial ability on firm performance through a mediator.

Introduction

In today’s fast-changing business climate, only focusing on the direct effect of managerial ability on firm performance may not fully reflect a manager’s ability to sustain competitive advantage. The current gap in the literature that links managerial ability to capital structure or firm performance, does so inadequately. Notably, although the literature shows that managerial ability has only unobservable effects on capital structure (Matemilola et al. 2013), there is less empirical evidence to show how it affects firm performance except for Ford and Shonkwiler (1994) and Wang et al. (2021). As a result, the association between managerial ability and firm performance may be considered spurious in the absence of a mediator. Thus, a study on the effect of managerial ability on firm performance via the role of a mediator is needed.

Additionally, literature has extensively examined the factors of corporate decision-making, including capital structure (Chen 2004; Chen et al. 2019; Huang et al. 2018; Klasa et al. 2018; Matemilola et al. 2019; Vo 2017) and firm performance (Hansen and Wernerfelt 1989; Hui et al. 2019; Huselid et al. 1997; Kafouros and Aliyev 2016; Liljeblom et al. 2019). A firm’s capital structure evidences managers’ abilities and affects profitability. According to the pecking order theory (Myers and Majluf 1984), if a company is profitable, it has retained earnings or cash for financing. Similarly, capital structure is a key factor in firm performance (Saeedi and Mahmoodi 2011). This is confirmed by agency theory (Jensen and Meckling 1976). Moreover, while managerial ability may explain a company’s debt level, Hackbarth (2008) suggests an association between managerial traits and capital structure decisions. Managers might have the ability, but their impact on firm performance may be indirect and operating through other variables such as capital structure. This mediating effect has not been investigated in the literature; hence, our study fills a much-needed gap.

Managerial ability has been proven to play an important determinant in tax avoidance, earnings quality, goodwill impairment, and other corporate policies. However, the relationship between investment opportunity and managerial ability has remained unclear for a long time, likely due to difficulty in measurement and other data limitations. This study focuses on how superior managerial ability affects investment opportunity for the following two reasons. First, as a crucial role in corporate finance, investment opportunity impacts a firm’s capital structure, dividend policy, and future growth (Smith and Watts (1992), Kallapur and Trombley (1999)). Second, because investment opportunity is unobservable by outsiders, it would be helpful if we could link investment opportunity to other firm characteristics and managerial ability. We argue that superior managers can understand industrial trends better, predict product demand more accurately, and invest in more value-creating projects, therefore associating themselves with better investment opportunity. Although the hypothesis we propose is somehow intuitive, a recent study in behavior corporate finance also shows that managers with a good reputation and compensation package may engage in more risk-averse and time preference projects that can harm investment opportunities (Graham, Campbell, and Manju (2013)). Moreover, we aim to find out whether the relation between managerial ability and investment opportunity varies under different financial conditions and economic environments. Rather than extrapolate the ability from managers’ characteristics, education background, personality traits, and working experience, we examine the relation by adopting the newly developed measure of managerial ability introduced by Demerjian, Lev, and McVay (2012) – namely, the MAscore (henceforth, we use MA-score to represent managerial ability). This measure follows a two-step procedure composed of data envelopment analysis and multivariate regression to quantify managers’ ef- ficiency in generating revenue. Prior research shows that the MA-score can reflect management-specific factors more precisely through several valid tests and is thus a better measure of managerial ability. The empirical evidence strongly supports our hypothesis, because our results document a significantly positive relation between managerial ability and investment opportunity, even after we control for firm fixed effects, year fixed effects, and other control variables. The empirical results indicate that managers with superior ability are related to more outstanding investment opportunities, as expected. In addition, we conduct a subsample test to look at how managerial ability’s impact on investment opportunity operates in different fi- nancial conditions and find that the result is more pronounced for firms with a low Kaplan-Zingales Index and a high Altman Z-score. Lastly, we interact the MA-score with the HHI dummy and Recession dummy to examine theirs correlations under different industrial and economic conditions and show that superior ability can mitigate the adverse effect of industry competition and financial crisis. For robustness, we conduct many different tests. First, we adopt Tobin’s q and the capital expenditure rate as alternative proxies for investment opportunity. Second, we use another methodology, first difference, to confirm the baseline regression. Third, we select the subsample of positive MAscores to re-run analysis. Fourth, we use 2SLS with instrumental variables, system simultaneous equations model (SEM), and Granger Causality to solve the endogenous problem.1 All results are still consistent with our expectation.

چکیده

این مطالعه این امر را بررسی می کند که آیا شرکت هایی که تحت نظر مدیران برتر فعالیت می کنند، می توانند با استفاده از داده های شرکت های صنعتی آمریکا در طی سال های 1988 تا 2015 به فرصت های سرمایه گذاری مطلوبتر دست پیدا کنند یا خیر. نتایج تجربی نشان می دهد که رابطه مثبتی بین توانایی مدیریتی و فرصت سرمایه گذاری وجود دارد و همچنین این رابطه تنها در شرکت هایی که از لحاظ مالی غیر محدود هستند یا شرکت هایی که در موقعیت مالی قوی قرار دارند معنادار می باشد. در کل یافته های ما از این حمایت می کند که شرکت هایی که مدیرانی با توانایی برتر دارند می توانند به منافع اقتصادی بیشتر از طریق فرصت های سرمایه گذاری بهتر دست پیدا کنند. از طریق تحقیق ما، سیاست گذاران و سرمایه گذاران می توانند توجه بیشتری به توانایی مدیریتی بنمایند.

1- مقدمه

توانایی مدیریتی اثبات کرده است که یک عامل تعیین کننده مهم در اجتناب از مالیات، کیفیت درآمد، و سایر سیاست های شرکت می باشد. با این حال رابطه بین فرصت سرمایه گذاری و توانایی مدیریتی برای مدت زمان زیادی نامعین مانده است که این به دلیل دشواری اندازه گیری و سایر محدودیت های داده ای می باشد. این مطالعه بر روی چگونگی تأثیرگذاری توانایی مدیران برتر بر فرصت های سرمایه گذاری به دو دلیل زیر تمرکز می کند. اولاً فرصت سرمایه گذاری بعنوان یک نقش حیاتی در امور مالی شرکت بر ساختار سرمایه ای شرکت، سیاست های سود سهام و رشد آینده تأثیر می گذارد. دوماً از آنجا که فرصت سرمایه گذاری توسط افراد خارجی قابل رویت نیست، اگر ما بتوانیم فرصت سرمایه گذاری را به سایر ویژگی های شرکت و توانایی مدیریتی مرتبط کنیم نتیجه مطلوبی خواهیم گرفت.

1. Introduction

2. Background and hypotheses

3. Methodology

4. Empirical results

5. Concluding

References

Abstract

The purpose of this paper is to study the influence of managerial ability on the quality of their financial reporting. Using a large bank sample from nine different countries and for the time period 2004–2010, we expect that bank earnings quality and accounting conservatism increase with more able managers that disclose more accurate earnings and who report higher information about banks’ future earnings and cash flows. The results confirm that managerial abilities play a significant role in the quality of financial reporting in banks, and that capable bank managers are less likely to manage earnings opportunistically. This study is timely and relevant given the recent emphasis on earnings quality of banks over the last few years, and the criticisms of managerial abilities after the financial crisis. The evidence from this study can help standard-setters and regulators to better understand the business practices and accounting behavior of banks in the light of managerial abilities.

Introduction

Do we know the factors that affect quality reporting in banks? Previous literature on financial reporting quality has mainly focused on the influence of governance characteristics of nonfinancial firms (Beekes, Pope, & Young, 2004; García Lara, García Osma, & Penalva, 2009). Several other studies have shown the association between financial reporting quality of non-financial firms and several management variables, such as CEO attributes (Francis, Huang, Rajgopal, & Zang, 2008; Koh, 2011), executive overconfidence (Schrand and Zechman 2009), and financial expertise (Matsunaga & Yeung, 2008). According to these studies, managers play a key role in the financial reporting process and exert a major influence on earnings through their operating decisions (Choi, Han, Jung, & Kang, 2015). These results are supported by the upper echelons theory, where managers are not effectively interchangeable, and idiosyncratic differences in personal values and cognitive styles can lead them to make different choices, particularly in complex situations (Bamber, Jiang, & Wang, 2010). These managerial abilities (MAs) are even more relevant in the bank industry due to the large informational asymmetries, opaqueness, and complexities of this sector (Levine, 2004). Despite the relevance of managerial ability, most of the previous literature has largely ignored the consequences of managerial skills on financial firms. However, banks have larger informational asymmetries and a different capital structure than non-financial firms. Managers in banks face superior complexity arising from many types of risks e credit risk, interest rate risk, prepayment risk, exchange rate risk, liquidity risk, among others (Craig Nichols, Wahlen, & Wieland, 2009). According to Bamber et al. (2010), in complex and ambiguous situations managers operate within the bounds of rationality, and within these bounds their choices can be influenced by their idiosyncratic experiences and values. Therefore, in order to prevent depositors losing confidence in banks and to avoid reputational losses, able managers may have a strong incentive to avoid their earnings becoming negative, which affects their accounting choices. In this regard, and according to Shen and Chih (2005), bank insiders have a high incentive to hide asset substitution behavior through earnings management, because bank assets present bankers with ample opportunities for risk or asset substitution, and their high leverage inclines them to do so.

Introduction

This study examines how the variation in CEO managerial ability impacts firms’ investment efficiency. Specifically, I investigate whether higher managerial ability contributes to improved investment practices when firms operate in an environment where under-investment or over-investment is very likely. Existing literature (Jensen 1986; Shleifer and Vishny 1989; Morck et al. 1990; Bertrand and Schoar 2003) suggests that CEOs’ individual attributes influence corporate investment practices and outcomes. Bertrand and Schoar (2003), for instance, find that a significant part of the heterogeneity in firms’ investment practices can be explained by unobserved manager-fixed effects, supporting the upper echelons theory in Hambrick and Mason (1984).1 Managers with different abilities view future prospects differently (Trueman 1986), and their differing views affect their judgments, confidence, and risk preferences. Moreover, managers with different levels of ability possess various skill sets, which in turn affect their perceptions and evaluations of potential investment opportunities. Therefore, I first predict that more able and less able CEOs behave differently in their investment practices. Further, I examine whether more able CEOs make more efficient investment decisions. Higher ability CEOs are perceived to have better knowledge and judgment than their peers, which enables them to better anticipate future changes (Trueman 1986). As a result, they are more likely to identify favorable investment opportunities. Consistent with this argument, Jian and Lee (2011) provide empirical evidence that investment decisions made by more reputable CEOs lead to better post-investment performance. This study takes another angle by examining how more able CEOs respond to an operating environment with a preexisting high likelihood of over-investment or under-investment. Holding other things constant, if CEO managerial ability contributes to improved investment efficiency, more able CEOs are expected to be associated with a decreased propensity for under-investment and/or over-investment. Prior studies (e.g., Scharfstein and Stein 1990) suggest that less able CEOs may ignore their own private information about payoffs and copy the decisions of previous managers, because they are afraid that they may be punished for their investment decisions by shareholders and markets. Such ignorance and herd behavior can lead to firms’ underinvestment or over-investment. In addition, without sufficient knowledge and capability, less able CEOs may fail to accurately anticipate future changes and employ inappropriate strategic views and poor evaluation techniques that lead to inefficient investment decisions. In contrast, more able CEOs pinpoint potential investment opportunities and make investment decisions that best fit their firms’ operating characteristics and strategic plans (Copeland et al. 1994). Further, with their private information, superior knowledge about business operations (i.e., firms’ cost structures and revenue drivers), and other skill sets, high ability CEOs are likely to arrive at more accurate estimates and evaluations of investments. This discussion suggests that, ceteris paribus, more able CEOs are likely to make more efficient investment decisions, which leads to less over- and/or underinvestment. In this study, I utilize the CEO managerial ability measure developed by Demerjian et al. (2012) to examine the above predictions. A CEO’s ability can be indicated by the efficiency with which he or she operates a firm, i.e., the degree to which a CEO generates more outputs by consuming fewer resources (Demerjian et al. 2012).

Abstract

Prior studies investigate the determinants and consequences of real earnings management (REM) as a function of firm-specific characteristics. In this study, we examine how managerial ability relates to the use of REM and future firm performance. We find that higher-ability managers engage in less REM. Furthermore, we find that managers with superior ability reduce the negative impact of REM on future firm performance. This is consistent with prior studies, which link higher-ability managers to better management of firm resources and more positive outcomes.

Introduction

This study examines the role of managerial ability in real earnings management (REM). REM is manager’s purposeful action that deviates from the optimal business practice to alter reported earnings in a particular direction (Roychowdhury, 2006). Prior studies (e.g., Cohen & Zarowin, 2010; Zang, 2012) focus on firm-level characteristics (e.g., the relative costs and constraints of REM and accrual-based earnings management) that lead to manager’s choice of REM. However, in addition to firm-level characteristics, executive characteristics may affect the use of REM. Our study investigates the relation between managerial ability and the use of REM. Furthermore, prior studies (e.g. Bhojraj, Hribar, Picconi, & McInnis, 2009; Cohen & Zarowin, 2010) suggest that REM is a value-destroying activity and has a negative impact on future firm performance. Our study sheds new light on the role of managerial ability in the relation between REM and future firm performance.

Abstract

We examine empirically the effect of managerial ability on firm-level investment efficiency and how this affects future stock price crash risk. Using a managerial ability measure developed by Demerjian et al. (2012), the paper documents consistent evidence that the more able managers over-invest compared to their not-so-able counterparts, even after controlling for the effects of financial reporting quality and other firm specific determinants of investment efficiency. This evidence is robust to alternative proxies for investment efficiency. The empirical evidence also suggests that crash risk increases for firms with more able managers, primarily through the investment inefficiency channel. Overall, the study contributes to a better understanding of the influence of managerial ability on investment decisions in the context of diverging opinions regarding manager-specific effects on organizational outcomes.

Introduction

We examine empirically the effect of managerial ability on firm-level investment efficiency and how this affects future stock price crash risk. Our study is motivated by the desire for a better assessment of the management’s impact on investment decisions and on stock price crash risk: an outcome of direct economic consequence for investors. According to the optimal investment argument proposed in the neo-classical framework, managers should continue investing until the marginal benefit of capital investment equals marginal costs. This proposition, however, is based on the assumption of no friction in the capital markets, i.e. managers obtain financing for positive net present value projects (NPVs) at the prevailing economy-wide interest rate and return excess cash to investors (e.g., Abel 1983; Hayashi, 1982; Yoshikawa, 1980). However, the agency theory view suggests that managerial self-interest might produce sub-optimal investment decisions resulting in both over- or under-investment. For example, both moral hazard and adverse selection imperfections inherent in the information asymmetry between managers and outside suppliers of capital, can adversely affect investment efficiency.

Managers intending to maximize their personal welfares are sometimes inclined to make investments that are not in the best interests of shareholders (Berle and Means, 1932; Jensen and Meckling, 1976; Jensen, 1986). Since there is divergence of incentives between mangers and investors, models of moral hazard suggest that managers will invest in negative NPVs. Models of adverse selection, on the other hand, suggest that if managers are better informed than investors about a firm’s prospects, they will try to time capital issuances to sell overpriced securities (i.e. a ‘lemons’ problem). If they are successful, they may over-invest these proceeds (e.g., Baker et al., 2003).

1- Introduction

2- Literature review and hypothesis development

3- Research design

4- Empirical results

5- Additional analysis

6- Conclusion

References

Abstract

This study examines whether the managerial ability of a chief executive officer (CEO) is associated with a marginal value of cash. We predict that more talented CEOs make better use of cash, creating the marginal value of cash. Using the managerial ability measures of Demerjian et al. (2012) and the cash value model developed by Faulkender and Wang (2006), we find that CEO managerial ability significantly increases the marginal value of cash. We also find that the effect of managerial ability on the marginal value of cash is generally greater for financially constrained firms. We further show that that the positive impact of managerial ability on the marginal value of cash is more evident for firms with higher levels of free cash flows and lower management entrenchment. Overall, our findings suggest that the market places a higher value on cash if the cash is managed by more able CEOs, which is consistent with the view that shareholders consider the ability of a CEO when they evaluate cash.

Introduction

In this study, we examine whether a firm’s marginal value of cash can be attributed to the firm’s CEO’s managerial ability. This study is motivated by the following. Cash is an important source of internal capital that is under the control of CEOs. That is, decisions about how to deploy cash are at the managers’ discretion (Liu & Mauer, 2011). A firm’s survival generally depends upon how effectively the firm manages its cash. Consistent with this view, a stream of research (e.g., Fazzari, Hubbard, & Petersen, 1988; Jensen, 1986; Pinkowitz & Williamson, 2004) shows that the value of cash depends on its availability and on how CEOs use it. In particular, Jensen (1986) argues that the individual characteristics of CEOs, such as personal interests and incentives, affect utilization of cash because available cash is under CEOs’ control. He also claims that managers may abuse their managerial discretion over the use of cash to pursue their own interests when the firm has a high level of cash. In particular, existing theoretical studies (e.g., Faulkender & Wang, 2006; Jensen, 1986; Myers & Majluf, 1984) suggest that a dollar of cash held by a firm may be valued at more than a dollar by its shareholders. For instance, Faulkender and Wang (2006) show that the marginal value of cash declines as cash reserves increase. Overall, prior evidence suggests that the marginal value of cash can be significantly influenced by CEOs’ ability. It is therefore critical for shareholders and investors to investigate how effectively managers utilize cash to maximize the marginal value of cash. Nonetheless, there is little research on the association between the marginal value of cash and managerial ability. Numerous studies (e.g., Baik, Farber, & Lee, 2011; Banker, Darrough, Huang, & Plehn-Dujowich, 2013; Carter, Franco, & Tuna, 2010; Chang, Dasgupta, & Hilary, 2010; Goodman, Neamtiu, Shroff, & White, 2013; Harris & Holmstrom, 1982; Jian & Lee, 2011; Rajgopal, Shevlin, & Zamora, 2006; Trueman, 1986) report that more able CEOs better manage a firm’s business operations, thereby enhancing the firm’s performance. In their theoretical work, Harris and Holmstrom (1982) argue that firms observe and assess a manager’s ability and the manager’s output over time and that a more experienced and high-ability manager’s productivity is perceived to be high. Recently, Demerjian, Lev, and McVay (2012) show that more able CEOs are expected to deliver a higher marginal outcome from the same level of resources, thereby enhancing the value of the firm. Accordingly, the marginal value of $1 of cash may not be valued at $1 by investors for various reasons, including managerial ability if high-quality CEOs generate a higher rate of output from given inputs than lower-quality CEOs (Demerjian et al., 2012). Thus, we argue that the marginal value of cash is impacted by management talents and should be higher than $1 if the cash is managed by more able managers.

To what extent might a firm’s performance be attributed to the ability of its CEO? Chang et al. (2010) broach this question and assert that the firm performance is indeed related to its CEO’s ability. Specifically, they note that a) abnormal returns of the old firm in conjunction with the turnover announcement is negatively related to its predeparture performance and the salary of its CEO; b) the CEO’s subsequent success is positively related to his salary with and performance of the old firm; c) the postturnover performance of the old firm deteriorates after the better-performing executives with higher salaries depart. The cumulative evidence leads Chang et al. to conclude these results Breject the view that differences in firm performance stem entirely from non-CEO factors such as the firms’ assets, other employees, or Bluck,^ and that CEO pay is unrelated to the CEO’s contribution to firm value^ (p.1633). In this paper, we extend the Chang et al. (2010) paper in three ways. First, we examine if the stock market can make a finer cross-sectional distinction among CEOs based on the level of performance of the associated firms. In doing so, we divide CEOs with better-than-average abilities in two groups: the better-performing group and good-performing group. Second, assuming that the job market would be able to recognize the differential managerial talents, we hypothesize that the CEOs with better abilities would find the job faster and command a higher compensation package than their good counterparts. Finally, we examine if there is (are) any additional attribute(s) that differentiate the first group from the second. We select from voluntary turnovers1 those CEOs that voluntarily leave the jobs are managers with superior ability and CEOs that are fired are of inferior ability. Empirical research supports this premise. For example, Warner et al. (1988) find poor performance as a predictor of forced CEO turnover. In Panel A, Table 2 (page 14), Parrino et al. (2003) compare mean market-adjusted compound abnormal returns between the forced group and the voluntary group and report the abnormal returns for the first group are −30.22%, −10.77%, −10.43%, −15.65% respectively for the holding periods of (−7, 0), (−7, −4), (−3, −2), and (−1, 0) – all being significant at the 1% level. The returns for the same periods, are −1.67%, −.43%, −1.60%, and .23% for the voluntary turnover firms—only (−3, −2) return being significant at the 10% level. Based on the empirically supported notion that voluntarily resigning CEOs are usually superior performers, we first divide these CEOs in two groups: Bbetter^ and Bgood^ performers. Consistent with Chang et al. (2010) we hypothesize that a) abnormal returns of firms from which better CEOs (henceforth, Tier-1) departed would be more negative than those from which good CEOs (henceforth, Tier-2) departed; b) abnormal returns of firms that hired Tier 1 CEOs would be more positive than those that hired Tier-2 CEOs. We also examine if the long-term performance of the hiring firms is consistent with the short-term returns around hiring announcements: in other words, we test if the firms that hire Tier-1 managers would exhibit higher long-term post-hire performance than their Tier-2 counterparts.

Business process outsourcing (BPO) project refers to projects where service providers accept, manage, and control business processes that a client entrusts and selects (Heffes, 2005; Liu et al., 2017). BPO projects can reduce cost and enhance the competitiveness of firms (Beverakis et al., 2009), but the implementation of these projects is unsatisfactory. According to a recent survey, approximately 50% of outsourcers believe that their outsourced business processes do not generate additional value, provide special knowledge, or reduce the expected cost for business operations management (Fersht, 2014). The process of BPO project implementation is subjected to numerous risks. Although previous studies investigated the relationship between risk and outsourcing project success, some research gaps remain unaddressed. Empirical evidence is lacking in the investigation of this relationship. For example, Alipour et al. (2011) argued that performance, financial, psychological, and strategic risks have negative effects on BPO projects, but no solid evidence was provided. Perçin (2008) divided BPO risks into six categories, namely, information security and privacy, hidden cost, loss of management control, employee morale, business environment, and service provider. They further proposed a fuzzy multi-index evaluation method to evaluate the risk effect, but the results lack practical data support. Therefore, the mechanism of how risks influence the success of BPO projects remains unclear. Previous studies also lack a comprehensive examination into different BPO risk types. Shi (2007) indicated that market performance and organizational risks of a customer will significantly affect long- and short-term performance of BPO; however, the risks of BPO proposed in the study are not comprehensive and only include three types. Based on a survey of 218 BPO projects in 126 banks, Gewald and Dibbern (2009) empirically showed that BPO project risk significantly affected success, but the effect of each type of risk (financial, psychological, and strategy risks) on performance was not analyzed. Herath and Kishore (2009) found that differences exist in the effect of risk on BPO project satisfaction in different contexts. They examined the risk of offshore BPO and contended that its impact differs from that of onshore BPO project risk. These studies have initially identified that BPO project risk has a negative effect on outsourcing project results (e.g., satisfaction). However, these studies did not conduct comprehensive risk identification. Many other risks exist in the BPO process (e.g., implementation and customer risk), but evidence for the effects of these additional risks are lacking. Further clarification on the mechanism of how different risks influence BPO project success or satisfaction is beneficial for developing differentiated and effective risk management strategies. Therefore, the first objective of this research is to address the effect of different types of risks on BPO project satisfaction.

Open innovation is crucial for a multinational enterprise (MNE) to maintain its competitive advantage and become a leader in the market. Open innovation has become increasingly important as a source of competitive advantage for a firm (Schneckenberg, 2015). Open innovation indicates that innovative performance can be improved by both acquiring knowledge from outside sources and employing external paths to commercialize knowledge resources developed internally. Innovation performance is often represented by the number of achievements (e.g., the quality of new products, new processes) (Hung, Lien, Yang, Wu, & Kuo, 2011). MNEs exhibit a tendency to seek access to others’ knowledge and technology in order to enhance their global competitiveness (Jasimuddin, Li, & Perdikis, 2015a; Steensma & Lyles, 2000). Park and Ghauri (2011) highlight key factors affecting the acquisition of technological capabilities of MNEs. Due to the challenges of market dynamism, MNEs have started to embrace the open innovation model, and reduce their reliance on the inward-looking closed innovation. Many MNEs currently engage in KM by adopting this model, in order to leverage knowledge both within their boundaries and externally to their stakeholders. MNEs such as Lucent, IBM, Intel and Millennium Pharmaceutical, DMS, P&G and ItalCementi are pioneers in adopting open innovation (Mortara & Minshall, 2011). In the knowledge-based society, MNEs face not only the challenge of offering innovative products and services through effective exploitation of knowledge resources available to them (Vaccaro, Jansen, Van Den Bosch, & Volberda, 2012), but also the challenge of how they capture and use the knowledge available outside their boundaries (Chesbrough & Crowther, 2006; Zahra & George, 2002; Zahra, Nielsen, & Bogner, 1999). Knowledge-based view of the firm regards knowledge as a strategic resource whereby the MNE can create value by exploring and exploiting it through its proper management and gain a competitive market position (Grant, 1996; Jasimuddin, Connell, & Klein, 2005; Zack, 1999). The proper management of knowledge demands leaders to influence their firm for constructive acquisition and application of knowledge (Ribiere & Sitar, 2003). Due to Shifting leadership from the industrial age to the knowledge era (Uhl-Bien, Marion, & McKelvey, 2007), knowledge-oriented leadership become a core factor in organizations to meet challenges in open innovation. For this, MNEs managers need knowledge management (KM) capability (i.e., infrastructure and process) to enhance open innovation. Although research interests in leadership and knowledge management (KM) capability is growing, limited empirical research has been directed towards the impact of knowledge-oriented leadership and KM capability on open innovation. There has been a growing interest among scholars and practitioners in the area of inbound and outbound open innovation. Donate and de Pablo (2015) pioneer in contributing to the leadership and knowledge management theory by presenting a model, which explains how knowledge-oriented leadership promotes effective KM. However, in order to account for the indirect role of leadership, they explore the linkage between knowledge-oriented leadership and innovation through KM practices. The study, however, overlooked how knowledge-oriented leadership might directly influence innovation outcomes. Hence, there is a research gap in explaining the direct association between knowledge-oriented leadership and open innovation outcomes (inbound OI and outbound OI). To the best of our knowledge, the empirical evidence of the intervening role of KM capability on the relationship between knowledge-oriented leadership and open innovation (inbound and outbound) is scant.