Recessions, Bank Distress, and Managerial Incentives to Innovate

Abstract

During recessions, managers prioritize innovative projects. This study explores how crises and bank distress influence managerial incentives to innovate. We find that exogenous shocks to CEO option pay during tough economic periods lead to increased patent production in subsequent years. This suggests managers may favor innovation when conventional projects become riskier due to heightened systematic risk. However, not all firms can effectively leverage these incentives. The effect is stronger in financially unconstrained firms with more market power or higher Z scores. Additionally, higher option pay can diminish future firm innovation if managers are more risk-averse or have greater personal stakes in their firm.

Keywords: Innovation, incentives, business cycle, executive compensation, option plans, bank distress.