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Is Pay for Performance Detrimental to Innovation?

Author

Listed:
  • Florian Ederer

    (Anderson School of Management, University of California, Los Angeles, Los Angeles, California 90095)

  • Gustavo Manso

    (Haas School of Business, University of California, Berkeley, Berkeley, California 94720)

Abstract

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.

Suggested Citation

  • Florian Ederer & Gustavo Manso, 2013. "Is Pay for Performance Detrimental to Innovation?," Management Science, INFORMS, vol. 59(7), pages 1496-1513, July.
    • Handle: RePEc:inm:ormnsc:v:59:y:2013:i:7:p:1496-1513
    DOI: 10.1287/mnsc.1120.1683
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