Pay Dispersion and Executive Behaviour:Evidence from Innovation

Compensation packages are widely used to motivate top executives. Pay dispersion among a firm's executives, however, can be associated with the antithetic effects of social comparison and individual motivation, with unclear implications for the company. We focus on innovation activities, which represent an important channel through which pay dispersion can affect firm performance, and test our predictions by exploring innovative output as a function of executives’ pay dispersion in a panel of US firms. We find that executive pay dispersion acts as a double-edged sword. On the one hand, the higher the dispersion in variable pay, the higher the innovation. On the other hand, the larger the dispersion in fixed pay, the lower the innovation. Results are robust to a number of tests, such as restricting the analysis to executives with direct responsibility for innovation projects and considering individual incentives in the form of cash pay.