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Motivating Innovation



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    • Gustavo Manso is at MIT Sloan School of Management. I thank John Roberts, Anat Admati, Darrell Duffie, and Ed Lazear for valuable discussions and suggestions. I also thank Peter DeMarzo, Bob Gibbons, Thomas Hellman, Bengt Holmstrom, Jim March, Pedro Miranda, Stew Myers, Tomasz Sadzik, Maria Salgado, Yuliy Sannikov, Antoinette Schoar, Andy Skrzypacz, Ilya Strebulaev, Alexei Tchistyi, Jeff Zwiebel, and seminar participants at the University of California at Berkeley, University of Chicago, Columbia University, Duke University, Harvard University, London Business School, London School of Economics, Massachusetts Institute of Technology, Northwestern University, New York University, Princeton University, Stanford University, University of California at Los Angeles, University of California at San Diego, University of Iowa, University of Oregon, and Wharton for helpful comments and Forrest Funnell for outstanding research assistance. Financial support from a Stanford Institute for Policy Research (SIEPR) Fellowship and the Lehman Brothers Fellowship for Research Excellence in Finance is gratefully acknowledged.


Motivating innovation is important in many incentive problems. This paper shows that the optimal innovation-motivating incentive scheme exhibits substantial tolerance (or even reward) for early failure and reward for long-term success. Moreover, commitment to a long-term compensation plan, job security, and timely feedback on performance are essential to motivate innovation. In the context of managerial compensation, the optimal innovation-motivating incentive scheme can be implemented via a combination of stock options with long vesting periods, option repricing, golden parachutes, and managerial entrenchment.