Innovation, R&D and Managerial Compensation

Abstract

This paper investigates whether aligning manager and owner incentives can improve the innovation performance of firms. We find that pay-sensitivity works to align managerial actions to shareholder interests. As managerial wealth becomes more sensitive to the firm’s stock price the innovation performance of a firm improves. Entrenched managers, however, are more likely to act myopically and follow strategies that result in a large number of low quality patents. Short-term incentives have little impact on innovation. Higher managerial tenure increases the probability of R&D spending and innovation quality and thus better aligns the managers’ actions with a firm’s long-term goals. CEO control of the firm, however, decreases its innovation performance.

Keywords: Patents, R&D, Incentive Alignment, Executive Compensation Contracts, Pay-Performance Sensitivity

JEL Classification: G32, G30, L2, O3