CEO Incentives and Corporate Innovation

Abstract

Abstract Using scaled wealth‐performance sensitivity as my measure of Chief Executive Officer (CEO) incentives, and utilizing cross‐sectional variations in industry innovativeness, product market competition and firms’ degree of exposure to the market for corporate control for identification purposes, I find that higher long‐term incentives that stem from CEO holdings of unvested options are associated with greater subsequent corporate innovation in innovative industries, competitive product markets, and firms more exposed to the threat of hostile takeovers, that is, exactly where incentivizing innovation is a matter of necessity. I address the endogeneity concerns with systems of simultaneous equations estimated using three‐stage least squares. A possible channel for the observed relation between unvested options‐based incentives and subsequent corporate innovation is that these incentives encourage managers to undertake riskier projects to achieve long‐term economic benefits.

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