Does CEO inside debt promote corporate innovation?

Abstract

Given the nature of innovation, optimal incentive schemes to motivate innovation should exhibit substantial tolerance for failure in the short-term and reward for success in the long-term. Inside debt such as pension and deferred compensation is a long-term commitment contract and largely independent of CEOs’ short-term performance, making them more willing to engage in long-term innovation activities. This study examines the role of inside debt in a CEO's compensation package and shows that inside debt is positively associated with innovation. However, I also find that a high balance of inside debt compared to equity incentives, such as stock and stock option holdings adversely affects the CEO's incentives to innovate, implying important cross-sectional differences in a firm's optimal inside debt policies for innovation. The results are consistent after controlling for firm and manager fixed effects and reverse causality problems.