Motivating High‐Impact Innovation: Evidence from Managerial Compensation Contracts

28 Pages Posted: 20 May 2020

See all articles by Bill Francis

Bill Francis

Rensselaer Polytechnic Institute (RPI) - Lally School of Management & Technology

Iftekhar Hasan

Fordham University ; Bank of Finland; University of Sydney

Zenu Sharma

St John's University; Rensselaer Polytechnic Institute

Maya Waisman

Fordham University - Gabelli School of Business

Date Written: August 2019

Abstract

We investigate the relationship between Chief Executive Officer (CEO) compensation and firm innovation and find that long‐term incentives in the form of options, especially unvested options, and protection from managerial termination in the form of golden parachutes are positively related to corporate innovation, and particularly to high‐impact, exploratory (new knowledge creation) invention. Conversely, non‐equity pay has a detrimental effect on the input, output and impact of innovation. Tests using the passage of an option expensing regulation (FAS 123R) as an exogenous shock to option compensation suggest a causal interpretation for the link between long‐term pay incentives, patents and citations. Furthermore, we find that the decline in option pay following the implementation of FAS 123R has led to a significant reduction in exploratory innovation and therefore had a detrimental effect on innovation output. Overall, our findings support the idea that compensation contracts that protect from early project failure and incentivize long‐term commitment are more suitable for inducing high‐impact corporate innovation.

Keywords: CEO compensation, innovation and incentives

JEL Classification: D8, O31

Suggested Citation

Francis, Bill and Hasan, Iftekhar and Sharma, Zenu and Waisman, Maya, Motivating High‐Impact Innovation: Evidence from Managerial Compensation Contracts (August 2019). Financial Markets, Institutions & Instruments, Vol. 28, Issue 3, pp. 291-318, 2019, Available at SSRN: https://ssrn.com/abstract=3601169 or http://dx.doi.org/10.1111/fmii.12115

Bill Francis (Contact Author)

Rensselaer Polytechnic Institute (RPI) - Lally School of Management & Technology ( email )

110 8th St
Troy, NY 12180
United States

Iftekhar Hasan

Fordham University ( email )

45 COLUMBUS AVENUE
GBA-5TH FLOOR
NEW YORK, NY 10023
United States

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

University of Sydney ( email )

P.O. Box H58
Sydney, NSW 2006
Australia

Zenu Sharma

St John's University ( email )

8000 Utopia Pkwy
Queens, NY 11439
United States
7189905496 (Phone)

Rensselaer Polytechnic Institute ( email )

Troy, NY 12180
United States

Maya Waisman

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
Bronx, NY 10458
United States

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