Agency Frictions, Managerial Compensation, and Disruptive Innovations
100 Pages Posted: 2 Feb 2019 Last revised: 11 Nov 2019
Date Written: November 8, 2019
Whether a manager leads the innovation efforts of a firm in line with shareholder preferences is key for firm value and growth. Motivated by empirical results suggesting corporate governance influences innovation mainly through executive compensation, we develop and estimate a new dynamic general equilibrium model of innovation with agency frictions and endogenous executive contracts. Removing agency frictions leads to contracts richer in stock options, boosting innovation by 27%, growth by 0.51pp, and welfare by 7.3%. These findings are robust to incorporating short-termism. Short-termism itself is also detrimental, the removal of which increases welfare by 1.5%. Removing both yields amplified gains.
Keywords: agency frictions, corporate governance, innovation, managerial compensation, short-termism
JEL Classification: E20, G30, O40
Suggested Citation: Suggested Citation