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Is Pay-for-Performance Detrimental to Innovation?

Florian Ederer

Yale School of Management; Yale University - Cowles Foundation

Gustavo Manso

University of California, Berkeley - Haas School of Business

October 31, 2012

Management Science, Vol. 59, Issue 7, pp. 1496-1513, July 2013

Previous research in economics shows that compensation based on the pay-for-performance principle is effective in inducing higher levels of effort and productivity. On the other hand, research in psychology argues that performance-based financial incentives inhibit creativity and innovation. How should managerial compensation be structured if the goal is to induce managers to pursue more innovative business strategies? In a controlled laboratory setting, we provide evidence that the combination of tolerance for early failure and reward for long-term success is effective in motivating innovation. Subjects under such an incentive scheme explore more and are more likely to discover a novel business strategy than subjects under fixed-wage and standard pay-for-performance incentive schemes. We also find evidence that the threat of termination can undermine incentives for innovation, while golden parachutes can alleviate these innovation-reducing effects.

Number of Pages in PDF File: 37

Keywords: innovation, incentives, exploration, tolerance for failure, experiments

JEL Classification: M52, O31, C91, M13

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Date posted: September 23, 2008 ; Last revised: January 13, 2015

Suggested Citation

Ederer, Florian and Manso, Gustavo, Is Pay-for-Performance Detrimental to Innovation? (October 31, 2012). Management Science, Vol. 59, Issue 7, pp. 1496-1513, July 2013. Available at SSRN: http://ssrn.com/abstract=1270384 or http://dx.doi.org/10.2139/ssrn.1270384

Contact Information

Florian Ederer (Contact Author)
Yale School of Management ( email )
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
HOME PAGE: http://faculty.som.yale.edu/florianederer/

Yale University - Cowles Foundation ( email )
Box 208281
New Haven, CT 06520-8281
United States

Gustavo Manso
University of California, Berkeley - Haas School of Business ( email )
545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
Feedback to SSRN

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