The Role of Intrinsic Incentives and Corporate Culture in Motivating Innovation

Abstract

This paper examines the optimal incentive scheme in motivating people to innovate under ambiguity. When an innovation's prospects are ambiguous, the use of extrinsic, high-powered incentives can lead the agent's beliefs about the project's outcome to deviate from that of the principal's, which consequently deters innovation. The deterrent effect, however, is alleviated for firms in which agents have strong intrinsic incentives to adhere to firms' goals and missions. In equilibrium, extrinsic and intrinsic incentives are complementary, and firms that face greater uncertainty invest more in fostering intrinsic incentives. Hence, firms that pursue more exploratory and radical innovation invest more in creating corporate identity and culture.

Keywords: compensation, optimal contracting, ambiguity, uncertainty, intrinsic incentives, innovation, corporate identity, corporate culture.

JEL Classification: D86, G30, O32