How to pay top executives if you want them to be innovative

When pay dispersion is perceived as linked to an executive’s individual performance (as in variable pay), it’s considered legitimate and may promote knowledge-sharing and cooperation among top executives. On the contrary, when pay dispersion is not perceived to depend on individual contribution (as in fixed pay), it ignites a demotivating process of social comparison, detrimental to knowledge sharing and cooperation.

That’s why high dispersion in variable top executives’ pay implies more innovation, while dispersion in fixed pay compromises it, according to a study by Mario Daniele Amore, an Associate Professor of Management and Technology at Bocconi University, Milan, with University of Bath’s Virgilio Failla, published on the British Journal of Management.

Up to now, managerial literature had observed the antithetic effects of pay dispersion on corporate results (incentivizing device, on the one hand, and determinant of social comparison on the other), but this new paper is able to measure the contribution of different forms of pay dispersion on the innovation output of a panel of US firms in a period spanning from 1992 to 2006.

As a measure of innovation, the authors use the number of patents granted by the US Patent and Trademark Office and the eventual citations received by such patents. Data on the compensation of the top executives of a set of American listed companies are drawn from the Standard&Poor’s Execucomp database.

In economic terms, fixed pay dispersion turns out to be more dangerous to tamper with than variable pay dispersion. &laquoTaken together, these findings suggest that firms that want to spur innovation need to carefully design their executives’ compensation by taking into account not just the level of pay but also the relative differences in each component of the pay package», Prof. Amore says.

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Mario Daniele Amore, Virgilio Failla, Pay Dispersion and Executive Behaviour: Evidence from Innovation, early view in the British Journal of Management, first published: 13 December 2018, DOI:10.1111/1467-8551.12337.