Innovative Activity and the Strategic Use of Managerial Incentives

Posted: 2 Sep 1999

See all articles by Michael L. Lemmon

Michael L. Lemmon

University of Utah - Department of Finance

Date Written: September 1994


This paper examines the strategic use of managerial compensation in an environment where a firm invests in projects which, if successful, can provide a competitive advantage over rival firms in the final product market. In particular, I study the interaction between managerial compensation policy and the investment strategies of competing firms in a model where the future stochastic payoffs from investment can depend on the firms' own actions as well as the actions taken by rivals. Examples of investments of this type include the development of new products/processes (e.g., expenditures on research and development (R&D)), the expansion of production capacity, and advertising and marketing campaigns aimed at increasing the firm's market share at the expense of rivals. It is shown that the strategic interaction between firms will generally result in overinvestment in innovation relative to a benchmark case in which compensation policy is not used in a strategic fashion.

JEL Classification: D43, G32

Suggested Citation

Lemmon, Michael L., Innovative Activity and the Strategic Use of Managerial Incentives (September 1994). Available at SSRN:

Michael L. Lemmon (Contact Author)

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States
801-585-5210 (Phone)
801-581-7214 (Fax)

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