Three key factors that drive management quality

In the last two weeks, I have written about how better management quality leads to higher productivity in firms. Last week, I teased that while UK manufacturing businesses generally have strong talent management practices, they still lag the US. Why is this? Or more generally, are there macroeconomic factors that systematically help improve management quality in firms and thus productivity? Today, I want to emphasise three of these factors.

Starting with people management and the ability to hire and promote high-performing employees while exiting underperformers, it should be no surprise that the structure of the local labour market has a significant influence on the quality of management practices. Why invest in better talent management when it is very hard to let underperformers go or promote employees on the quality of their work rather than tenure or their connections to the CEO?

Below is a chart that shows the link between labour market rigidity and management quality. Countries with more rigid labour markets like Bolivia or Venezuela have very low people management quality. But even within Europe, countries like France, Greece, or Spain with their less flexible labour markets have lower people management quality on average than the UK or Ireland. Of course, labour market flexibility is not a panacea. Germany has a rather rigid labour market and still boasts very high people management quality.

People management quality improves in more flexible labour markets

Source: World Management Survey 2024

Conversely, one can argue that if a government reduces labour market flexibility (for example by reducing the rights of employees or the influence of labour unions), it creates more competition among companies for skilled workers and as a result better management practices to hire the best people. This, in turn, creates a more productive workforce for the businesses that can attract the best people.

This brings me to another driver of better management quality that is linked to the people working at a business. Only this time it is about the people on the top.

Businesses that are controlled by the founder or the family of the founder tend to have lower management quality than businesses that are controlled by a diverse shareholder base or private equity. In essence, the less oversight and control there is for the top brass in a company, the worse the management quality tends to get and the more a business loses productivity.

Ownership structure and management practices

Source: World Management Survey 2024

Finally, let me point out one final driver of good management practices: Competition.

The research is unequivocal. More competition is good for business and its management practices. Competition forces a business to innovate and become more productive. Conversely, if a business is protected from competition, say (for no apparent reason whatsoever) because the government introduced tariffs to protect domestic businesses from foreign competitors, the more management practices and productivity deteriorate.

One way to show this is to compare multinational companies with domestic companies in a country. Multinational companies tend to have significantly better management practices even when controlled for the typically larger size and better financial resources of multinationals. The exposure to more competitors globally incentivises multinationals to adopt best practices from different countries and regions and thus improve management quality in the business everywhere. The result is a significant increase in productivity. And as we all know – or should know – higher productivity growth means higher salaries for employees.

Meanwhile, protecting domestic employers from foreign competition reduces the drive to innovate and manage the firm in the best way possible, drives down productivity growth, and eventually leads to lower salaries for employees in these protected businesses.

Management practices of multinationals vs. domestic firms

Source: World Management Survey 2024