R&R Journal of Financial Economics
Innovating firms face a dilemma when setting contractual terms for management. Competing theories make opposing predictions on the relationship between contract-duration and innovation. Using novel data, we estimate that an additional year of CEO-contract-duration leads to 6.5% higher-quality innovation. We support a causal interpretation by exploiting exogenous variation spurred by CEO contract-limits regulation. Our evidence illustrates the process of changing innovation quality. Longer-contract-horizon CEOs allocate more resources to exploratory R&D and set longer term incentives for CROs. The evidence is consistent with the view that longer contracts facilitate long-term investment and greater risk-taking by mitigating managerial myopia and career concerns.
Juanita Gonzalez-Uribe and Moqi Groen-Xu