Essays on human capital, risk-taking, and innovation

Abstract

This thesis consists of three independent essays on human capital, risk-taking, and corporate innovation. The first essay examines whether the first-hand experience of doing innovation endows CEOs with a superior ability to evaluate, select, and execute innovative investment projects for their firms. We show firms led by “Inventor CEOs” are associated with higher quality innovation, especially when the CEO is a high-impact inventor. During an Inventor CEO’s tenure, firms file a greater number of patents and more valuable patents in technology classes where the CEO’s hands-on experience lies. Utilizing plausibly exogenous CEO turnovers to address the matching of CEOs to firms suggests these effects are causal. Our findings provide a new human-capital based explanation for why some firms are more innovative than others. The second essay examines whether happier employees are more innovative by exploring the relationship between employee-friendliness and innovation. The study uses the staggered adoption of the Inevitable Disclosure Doctrine (IDD) by various U.S. states as an exogenous shock that shuts off an important external source of employee motivation to innovate. Innovation within employee-friendly firms appears to be largely immune to this external shock, whereas unfriendly firms suffer significant declines in innovation outputs. This is because the intrinsic motivation provided to the employees is powerful enough to make external motivators such as mobility less important. The findings suggest that firms’ investments in the satisfaction of employees play important innovation enhancing role. The third essay examines the extent to which the design of executive compensation contracts addresses the mismatch in risk-preferences of undiversified managers and diversified shareholders. Exogenous variations in manager risk preference are obtained from externally triggered negative mobility shocks. These shocks raise the cost of a performance-related termination while also preventing executives from participating in industry tournaments, both of which make risk-taking less attractive. The study documents that the executive pay-setting process responds to this reduction in implicit risk-taking incentives by increasing explicit risk-taking incentives in compensation contracts. The results shed light on the extent to which the structure of executive compensation is chosen with the alignment of the risk-preferences of managers and shareholders in mind.