IDEAS home Printed from https://ideas.repec.org/a/wly/finmar/v28y2019i3p291-318.html
   My bibliography  Save this article

Motivating high‐impact innovation: Evidence from managerial compensation contracts

Author

Listed:
  • Bill B. Francis
  • Iftekhar Hasan
  • Zenu Sharma
  • Maya Waisman

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.

Suggested Citation

  • Bill B. Francis & Iftekhar Hasan & Zenu Sharma & Maya Waisman, 2019. "Motivating high‐impact innovation: Evidence from managerial compensation contracts," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 28(3), pages 291-318, August.
    • Handle: RePEc:wly:finmar:v:28:y:2019:i:3:p:291-318
    DOI: 10.1111/fmii.12115
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/fmii.12115
    Download Restriction: no
    File URL: https://libkey.io/10.1111/fmii.12115?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Gustavo Manso, 2011. "Motivating Innovation," Journal of Finance, American Finance Association, vol. 66(5), pages 1823-1860, October.
    2. Julian Atanassov, 2013. "Do Hostile Takeovers Stifle Innovation? Evidence from Antitakeover Legislation and Corporate Patenting," Journal of Finance, American Finance Association, vol. 68(3), pages 1097-1131, June.
    3. Holmstrom, Bengt, 1989. "Agency costs and innovation," Journal of Economic Behavior & Organization, Elsevier, vol. 12(3), pages 305-327, December.
    4. Philippe Aghion & John Van Reenen & Luigi Zingales, 2013. "Innovation and Institutional Ownership," American Economic Review, American Economic Association, vol. 103(1), pages 277-304, February.
    5. Bill Francis & Iftekhar Hasan & Ying Huang & Zenu Sharma, 2012. "Do Banks Value Innovation? Evidence from US Firms," Financial Management, Financial Management Association International, vol. 41(1), pages 159-185, March.
    6. Pierre Azoulay & Joshua S. Graff Zivin & Gustavo Manso, 2011. "Incentives and creativity: evidence from the academic life sciences," RAND Journal of Economics, RAND Corporation, vol. 42(3), pages 527-554, September.
    7. Bronwyn H. Hall & Adam Jaffe & Manuel Trajtenberg, 2005. "Market Value and Patent Citations," RAND Journal of Economics, The RAND Corporation, vol. 36(1), pages 16-38, Spring.
    8. Ellie G. Harris, 1990. "Antitakeover Measures, Golden Parachutes, and Target Firm Shareholder Welfare," RAND Journal of Economics, The RAND Corporation, vol. 21(4), pages 614-625, Winter.
    9. Chandra Subramaniam & Lane A. Daley, 2000. "Free Cash Flow, Golden Parachutes, and the Discipline of Takeover Activity," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 27(1‐2), pages 1-36, January.
    10. Philippe Aghion & Jean Tirole, 1994. "The Management of Innovation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 109(4), pages 1185-1209.
    11. David Hirshleifer & Angie Low & Siew Hong Teoh, 2012. "Are Overconfident CEOs Better Innovators?," Journal of Finance, American Finance Association, vol. 67(4), pages 1457-1498, August.
    12. Hall, B. & Jaffe, A. & Trajtenberg, M., 2001. "The NBER Patent Citations Data File: Lessons, Insights and Methodological Tools," Papers 2001-29, Tel Aviv.
    13. Dirk Bergemann & Ulrigh Hege, 2005. "The Financing of Innovation: Learning and Stopping," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 719-752, Winter.
    14. Paul Gompers & Joy Ishii & Andrew Metrick, 2003. "Corporate Governance and Equity Prices," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(1), pages 107-156.
    15. Lambert, Richard A. & Larcker, David F., 1985. "Golden parachutes, executive decision-making, and shareholder wealth," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 179-203, April.
    16. Leonid Kogan & Dimitris Papanikolaou & Amit Seru & Noah Stoffman, 2017. "Technological Innovation, Resource Allocation, and Growth," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 132(2), pages 665-712.
    17. Sudip Datta & Mai Iskandar‐Datta & Kartik Raman, 2001. "Executive Compensation and Corporate Acquisition Decisions," Journal of Finance, American Finance Association, vol. 56(6), pages 2299-2336, December.
    18. William N. Pugh & Daniel E. Page & John S. Jahera, 1992. "Antitakeover Charter Amendments: Effects On Corporate Decisions," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 15(1), pages 57-67, March.
    19. Shahbaz Sheikh, 2012. "Do CEO compensation incentives affect firm innovation?," Review of Accounting and Finance, Emerald Group Publishing Limited, vol. 11(1), pages 4-39, February.
    20. Francis, Bill B. & Hasan, Iftekhar & John, Kose & Waisman, Maya, 2010. "The effect of state antitakeover laws on the firm's bondholders," Journal of Financial Economics, Elsevier, vol. 96(1), pages 127-154, April.
    21. Gormley, Todd A. & Matsa, David A. & Milbourn, Todd, 2013. "CEO compensation and corporate risk: Evidence from a natural experiment," Journal of Accounting and Economics, Elsevier, vol. 56(2), pages 79-101.
    22. Josh Lerner & Julie Wulf, 2007. "Innovation and Incentives: Evidence from Corporate R&D," The Review of Economics and Statistics, MIT Press, vol. 89(4), pages 634-644, November.
    23. Xuan Tian & Tracy Yue Wang, 2014. "Tolerance for Failure and Corporate Innovation," The Review of Financial Studies, Society for Financial Studies, vol. 27(1), pages 211-255, January.
    24. Seru, Amit, 2014. "Firm boundaries matter: Evidence from conglomerates and R&D activity," Journal of Financial Economics, Elsevier, vol. 111(2), pages 381-405.
    25. Gaver, Jennifer J. & Gaver, Kenneth M., 1993. "Additional evidence on the association between the investment opportunity set and corporate financing, dividend, and compensation policies," Journal of Accounting and Economics, Elsevier, vol. 16(1-3), pages 125-160, April.
    26. Sayili, Koray & Yilmaz, Gokhan & Dyer, Douglas & Küllü, A. Melih, 2017. "Style investing and firm innovation," Journal of Financial Stability, Elsevier, vol. 32(C), pages 17-29.
    27. Daniel A. Levinthal & James G. March, 1993. "The myopia of learning," Strategic Management Journal, Wiley Blackwell, vol. 14(S2), pages 95-112, December.
    28. Jongseok Lee & Jeho Lee & Habin Lee, 2003. "Exploration and Exploitation in the Presence of Network Externalities," Management Science, INFORMS, vol. 49(4), pages 553-570, April.
    29. Baranchuk, Nina & Kieschnick, Robert & Moussawi, Rabih, 2014. "Motivating innovation in newly public firms," Journal of Financial Economics, Elsevier, vol. 111(3), pages 578-588.
    30. Francis, Bill B. & Hasan, Iftekhar & John, Kose & Waisman, Maya, 2016. "Urban Agglomeration and CEO Compensation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 51(6), pages 1925-1953, December.
    31. David H. Erkens, 2011. "Do Firms Use Time‐Vested Stock‐Based Pay to Keep Research and Development Investments Secret?," Journal of Accounting Research, Wiley Blackwell, vol. 49(4), pages 861-894, September.
    32. He, Jie (Jack) & Tian, Xuan, 2013. "The dark side of analyst coverage: The case of innovation," Journal of Financial Economics, Elsevier, vol. 109(3), pages 856-878.
    33. Rajgopal, Shivaram & Shevlin, Terry, 2002. "Empirical evidence on the relation between stock option compensation and risk taking," Journal of Accounting and Economics, Elsevier, vol. 33(2), pages 145-171, June.
    34. Hausman, Jerry & Hall, Bronwyn H & Griliches, Zvi, 1984. "Econometric Models for Count Data with an Application to the Patents-R&D Relationship," Econometrica, Econometric Society, vol. 52(4), pages 909-938, July.
    35. Haugen, Robert A & Senbet, Lemma W, 1981. "Resolving the Agency Problems of External Capital through Options," Journal of Finance, American Finance Association, vol. 36(3), pages 629-647, June.
    36. John Core & Wayne Guay, 2002. "Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility," Journal of Accounting Research, Wiley Blackwell, vol. 40(3), pages 613-630, June.
    37. Thomas Hellmann, 2007. "When Do Employees Become Entrepreneurs?," Management Science, INFORMS, vol. 53(6), pages 919-933, June.
    38. Lambert, Ra & Larcker, Df & Verrecchia, Re, 1991. "Portfolio Considerations In Valuing Executive-Compensation," Journal of Accounting Research, Wiley Blackwell, vol. 29(1), pages 129-149.
    39. Dechow, Patricia M. & Sloan, Richard G., 1991. "Executive incentives and the horizon problem : An empirical investigation," Journal of Accounting and Economics, Elsevier, vol. 14(1), pages 51-89, March.
    40. Lucian Bebchuk & Alma Cohen & Allen Ferrell, 2009. "What Matters in Corporate Governance?," The Review of Financial Studies, Society for Financial Studies, vol. 22(2), pages 783-827, February.
    41. Core, John & Guay, Wayne, 1999. "The use of equity grants to manage optimal equity incentive levels," Journal of Accounting and Economics, Elsevier, vol. 28(2), pages 151-184, December.
    42. Daniel A. Cohen & Aiyesha Dey & Thomas z. Lys, 2013. "Corporate Governance Reform and Executive Incentives: Implications for Investments and Risk Taking," Contemporary Accounting Research, John Wiley & Sons, vol. 30(4), pages 1296-1332, December.
    43. Tu Nguyen, 2018. "CEO Incentives and Corporate Innovation," The Financial Review, Eastern Finance Association, vol. 53(2), pages 255-300, May.
    44. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(4), pages 391-405, December.
    45. Meulbroek, Lisa K & Mitchell, Mark L & Mulherin, J Harold & Netter, Jeffry M & Poulsen, Annette B, 1990. "Shark Repellents and Managerial Myopia: An Empirical Test," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 1108-1117, October.
    46. Laux, Volker, 2012. "Stock option vesting conditions, CEO turnover, and myopic investment," Journal of Financial Economics, Elsevier, vol. 106(3), pages 513-526.
    47. Lawrence D. Brown & Yen-Jung Lee, 2011. "Changes in Option-Based Compensation Around the Issuance of SFAS 123R," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 38(9-10), pages 1053-1095, November.
    48. Frank T. Rothaermel & David L. Deeds, 2004. "Exploration and exploitation alliances in biotechnology: a system of new product development," Strategic Management Journal, Wiley Blackwell, vol. 25(3), pages 201-221, March.
    49. Cynthia E. Devers & Gerry McNamara & Robert M. Wiseman & Mathias Arrfelt, 2008. "Moving Closer to the Action: Examining Compensation Design Effects on Firm Risk," Organization Science, INFORMS, vol. 19(4), pages 548-566, August.
    50. Amore, Mario Daniele & Schneider, Cédric & Žaldokas, Alminas, 2013. "Credit supply and corporate innovation," Journal of Financial Economics, Elsevier, vol. 109(3), pages 835-855.
    51. Knoeber, Charles R, 1986. "Golden Parachutes, Shark Repellents, and Hostile Tender Offers," American Economic Review, American Economic Association, vol. 76(1), pages 155-167, March.
    52. Hayes, Rachel M. & Lemmon, Michael & Qiu, Mingming, 2012. "Stock options and managerial incentives for risk taking: Evidence from FAS 123R," Journal of Financial Economics, Elsevier, vol. 105(1), pages 174-190.
    53. repec:eme:mfppss:v:35:y:2009:i:4:p:346-356 is not listed on IDEAS
    54. Mehran, Hamid & Nogler, George E. & Schwartz, Kenneth B., 1998. "CEO incentive plans and corporate liquidation policy," Journal of Financial Economics, Elsevier, vol. 50(3), pages 319-349, December.
    55. Chandra Subramaniam & Lane A. Daley, 2000. "Free Cash Flow, Golden Parachutes, and the Discipline of Takeover Activity," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 27(1&2), pages 1-36.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Chang, Xin & Fu, Kangkang & Low, Angie & Zhang, Wenrui, 2015. "Non-executive employee stock options and corporate innovation," Journal of Financial Economics, Elsevier, vol. 115(1), pages 168-188.
    2. Tu Nguyen & Jing Zhao, 2021. "Industry tournament incentives and corporate innovation," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 48(9-10), pages 1797-1845, October.
    3. Caroline Flammer & Aleksandra Kacperczyk, 2016. "The Impact of Stakeholder Orientation on Innovation: Evidence from a Natural Experiment," Management Science, INFORMS, vol. 62(7), pages 1982-2001, July.
    4. Francis, Bill & Mani, Suresh Babu & Sharma, Zenu & Wu, Qiang, 2021. "The impact of organization capital on firm innovation," Journal of Financial Stability, Elsevier, vol. 53(C).
    5. Blanco, Iván & Wehrheim, David, 2017. "The bright side of financial derivatives: Options trading and firm innovation," Journal of Financial Economics, Elsevier, vol. 125(1), pages 99-119.
    6. Ching-Hung Chang & Qingqing Wu, 2021. "Board Networks and Corporate Innovation," Management Science, INFORMS, vol. 67(6), pages 3618-3654, June.
    7. Francis, Bill & Hasan, Iftekhar & Sharma, Zenu, 2011. "Incentives and innovation : evidence from CEO compensation contracts," Research Discussion Papers 17/2011, Bank of Finland.
    8. repec:zbw:bofrdp:2011_017 is not listed on IDEAS
    9. Wang, Jimin & Ho, Choy Yeing (Chloe) & Shan, Yuan George, 2024. "Does cybersecurity risk stifle corporate innovation activities?," International Review of Financial Analysis, Elsevier, vol. 91(C).
    10. Yang, Huan, 2021. "Institutional dual holdings and risk-shifting: Evidence from corporate innovation," Journal of Corporate Finance, Elsevier, vol. 70(C).
    11. Hasan, Iftekhar & (Stan) Hoi, Chun-Keung & Wu, Qiang & Zhang, Hao, 2020. "Is social capital associated with corporate innovation? Evidence from publicly listed firms in the U.S," Journal of Corporate Finance, Elsevier, vol. 62(C).
    12. Huang, Minjie & Kubick, Thomas R. & Tseng, Kevin, 2021. "Technology spillovers and the duration of executive compensation," Journal of Banking & Finance, Elsevier, vol. 131(C).
    13. Moshirian, Fariborz & Tian, Xuan & Zhang, Bohui & Zhang, Wenrui, 2021. "Stock market liberalization and innovation," Journal of Financial Economics, Elsevier, vol. 139(3), pages 985-1014.
    14. Francis, Bill & Hasan, Iftekhar & Sharma, Zenu, 2011. "Incentives and innovation: evidence from CEO compensation contracts," Bank of Finland Research Discussion Papers 17/2011, Bank of Finland.
    15. Ramana Nanda & William R. Kerr, 2015. "Financing Innovation," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 445-462, December.
    16. Julian Atanassov, 2016. "Arm’s Length Financing and Innovation: Evidence from Publicly Traded Firms," Management Science, INFORMS, vol. 62(1), pages 128-155, January.
    17. Lingfei Kong & Gunratan Lonare & Ahmet Nart, 2022. "Industry tournament incentives and corporate innovation strategies," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 45(1), pages 124-161, March.
    18. Nguyen, Lily & Vu, Le & Yin, Xiangkang, 2020. "The undesirable effect of audit quality: Evidence from firm innovation," The British Accounting Review, Elsevier, vol. 52(6).
    19. Ho, Po-Hsin & Huang, Chia-Wei & Lin, Chih-Yung & Yen, Ju-Fang, 2024. "Risk culture in corporate innovation," International Review of Financial Analysis, Elsevier, vol. 91(C).
    20. Kong, Dongmin & Zhang, Bohui & Zhang, Jian, 2022. "Higher education and corporate innovation," Journal of Corporate Finance, Elsevier, vol. 72(C).
    21. Francis, Bill B. & Hasan, Iftekhar & Hunter, Delroy M. & Zhu, Yun, 2017. "Do managerial risk-taking incentives influence firms' exchange rate exposure?," Journal of Corporate Finance, Elsevier, vol. 46(C), pages 154-169.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wly:finmar:v:28:y:2019:i:3:p:291-318. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.