Optimal Incentives for Corporate Innovation

Abstract

We propose a simple model to analyze the optimal incentives for corporate innovation. In our model, the manager must be motivated to exert R\&D effort and to decide optimally whether to innovate conditional on the information generated by her effort. Importantly, we assume that the manager's decision whether to innovate is observable, so the contract can condition pay not only on outcomes but also on whether the manager innovates. We show that the optimal contract makes pay-performance sensitivity higher if the manager decides to innovate. We also show that the optimal contract depends on factors not considered in prior work on the motivation of innovation.