Journal Article

Is Pay for Performance Detrimental to Innovation?

Manso, Gustavo, Ederer, Florian

2013

Overview

Previous research in economics shows that compensation based on the pay-for-performance principle is effective in inducing higher levels of effort and productivity. On the other hand, research in psychology argues that performance-based financial incentives inhibit creativity and innovation. How should managerial compensation be structured if the goal is to induce managers to pursue more innovative business strategies? In a controlled laboratory setting, we provide evidence that the combination of tolerance for early failure and reward for long-term success is effective in motivating innovation. Subjects under such an incentive scheme explore more and are more likely to discover a novel business strategy than subjects under fixed-wage and standard pay-for-performance incentive schemes. We also find evidence that the threat of termination can undermine incentives for innovation, whereas golden parachutes can alleviate these innovation-reducing effects. This paper was accepted by David Hsu, entrepreneurship and innovation.

• Publisher: INFORMS,Institute for Operations Research and the Management Sciences
• Subject: Business / Business creativity / Business innovation / Business strategies / Compensation / Creativity / Economic aspects / Economic research / Economics / Employee incentives / Employee motivation / Entrepreneurship / Executive compensation / Experimental economics / Experiments / Financial incentives / Golden parachute / Golden parachutes / Hypotheses / Incentive pay / Incentive plans / Incentives / Innovation / Innovations / Laboratories / Management science / Methods / Monetary incentives / Motivation / motivation incentives / organizational studies / P values / Pay for performance / Performance related pay / personnel / Product mixes / Productivity / Psychological aspects / Psychological research / Psychology / R&D / Research & development / Research and development / Risk aversion / Statistical significance / Strategies / Studies / Success / Termination / Tolerance / Wages / Wages & salaries