The Real Effects of Tournament Incentives: The Case of Firm Innovation

Abstract

This paper examines the effects of promotion-based tournament incentives for non-CEO executives on corporate innovation. We find that firms with greater tournament incentives, which are measured as the pay gap between the CEO and other executives, are associated with a higher level of patent quantity and quality, innovation efficiency, and patent importance and novelty. An instrumental variable approach suggests that the observed relations are unlikely to be caused by endogeneity in tournament incentives. The attraction of talent and the reduction in excessive board interventions appear two plausible underlying mechanisms through which tournament incentives promote firm innovation. Our paper highlights the importance of inter-executive incentive scheme design in encouraging technological innovation.

Keywords: Tournament incentives, executive compensation, innovation, human capital, board monitoring

JEL Classification: G30; G34; J31; J33; O32