Motivating Innovation in Newly Public Firms

Abstract:     
Manso (2010) and Hellmann and Thiele (2011) develop models to examine what factors influence the incentives of an agent to pursue innovative activities. Manso argues that incentive compensation, long vesting periods for unexercised options, and tolerance for failure encourage a CEO to pursue innovative activities. We examine whether his arguments are consistent with these features in newly public firms using a sample of U.S. IPOs from 2000 to 2004. First, we find evidence that the length of the vesting period of a CEO’s unexercised options is positively related to the firm’s expected innovative outcomes. Second, the firm’s use of external antitakeover defenses is positively related to both the maximum vesting period of the CEO’s unexercised options and the firm’s expected innovative outcomes. Third, we find evidence that the size of the CEO’s incentive compensation is positively correlated with his firm’s expected innovative outcomes. Fourth, we find evidence consistent with market recognizing the optimality of the IPO firm’s incentive structure. And finally, we find evidence that the firm’s innovative outcomes after going public are positively correlated with its CEO incentive compensation, the maximum vesting period of his unexercised options and internal governance restrictions. By and large, our evidence is consistent with Manso’s (2010) model of what motivates managers to pursue innovation in newly public firms.

Number of Pages in PDF File: 28

Keywords: innovation, corporate governance, incentive contracts

JEL Classification: G34, L20

working papers series