"Is Good Governance Always Good? Innovation, Governance, and Performance Feedback"

Abstract

Is good governance good for innovation? Innovation requires tolerance for failure, but reduced accountability is also prone to moral hazard, creating a tension in the effects of reducing managerial entrenchment on innovation. Leveraging insights from the Behavioral Theory of the Firm, specifically the non-linear increase in managerial benefits from improving performance around performance targets, we theorize that managerial preference for risk-taking and moral hazard is contingent on the risk of underperformance. As a result, reducing managerial entrenchment has detrimental effects in firms that face the risk of underperformance and suffer from increased risk aversion but has beneficial effects in overperforming firms exposed to the increased risk of moral hazard. We find empirical support based on staggered adoptions of anti-takeover statutes and block institutional ownership and suggest the consequences of governance choice to be dynamic, having different effects even within a single firm over time dep...