72 Pages Posted: 21 Mar 2006 Last revised: 25 Oct 2014
Date Written: November 26, 2010
Motivating innovation is an important concern in many incentive problems. For example, shareholders of large corporations often need to motivate managers to pursue more innovative business strategies. This paper shows that the optimal incentive scheme that motivates innovation exhibits substantial tolerance (or even reward) for early failure and reward for long-term success. Moreover, commitment to a long-term compensation plan, job security, and timely feedback on performance are also essential ingredients to motivate innovation. In the context of managerial compensation, the optimal incentive scheme that motivates innovation can be implemented via a combination of stock options with long vesting periods, option repricing, golden parachutes, and managerial entrenchment.
Keywords: Incentives, innovation, exploration and exploitation, learning
JEL Classification: D83, G32, G34, M13, M52, M54
Suggested Citation: Suggested Citation