Managerial Incentives to Innovate During Crises: The Schumpeterian View

Abstract

Existing literature offers opposing views on the effects of financial crises on firm innovation. We provide evidence supporting the Schumpeter’s view of the creative destruction of crises. We identify one specific channel, the internal compensation mechanism that firms use to motivate managers to innovate during crises, as an important driver that improves firm innovative output. We show that during financial crises, increasing managerial option pay leads to firms producing more, higher quality patents as compared to normal times. Moreover, we find that less financially constrained firms are relatively better able to innovate by compensating managers with options. We identify exogenous variation in option compensation using multiyear option plans. Our results indicate that crises provide unique growth opportunities for innovative firms.