Recessions, Bank Distress & Managerial Incentives to Innovate

Abstract

Recessions shake financial markets. Are managerial incentives to innovate impacted by crises and resulting bank distress? We show that exogenous shocks to CEO option pay awarded in bad times lead to firms producing more patents in future years. These results are consistent with risk-averse managers choosing to innovate more in bad times, which is when conventional projects are riskier due to the overall higher systematic risk in markets. Benefits of choosing the ‘safer’ conventional project shrink in bad times. In normal times (i.e., unconditionally), increasing CEO option pay does not impact future firm innovation. We also show that when managers are more risk averse or have more ‘skin in the game,’ increasing their option pay reduces future firm innovation, consistent with higher risk-sharing costs.

Keywords: Innovation, incentives, skin in the game, executive compensation, option plans, bank distress

JEL Classification: G01, G34