The Incentives for Innovative Activity in the Managerial Firm.

This paper discusses the incentives for innovation by a manager-led firm. In particular, it is investigated how remuneration practices influence the choice of a risky project. In the first place, a dynamic model with uncertainty is used to determine the optimal employment level with exogenous growth and risk. In the second part of the paper, growth and risk are explained by R&D expenditures. Optimal investment expenditures for R&D are derived for (i) the profit-maximizing firm and (ii) the managerial firm, where the manager receives a fixed salary as well as a variable share of profits. If risk neutrality is assumed, then no difference exists. However, if risk aversion is considered, the managerial firm will invest more into R&D than the owner-led company. Size-related salaries are an additional reason for higher expenditures of R&D by managers. Copyright © 2013 John Wiley & Sons, Ltd. [ABSTRACT FROM AUTHOR]