In this paper, we focus on team-based compensation design and examine the effect of synergistic incentives among executives on corporate innovation performance. Building on Edmans et al. (2013) and Bushman et al. (2016), we use dispersion in Pay Performance Sensitivities (PPS) among top executives as a proxy for the synergy component of a management team’s incentive. We model optimal PPS dispersion and use residuals from this model to capture deviations from the optimal. Innovation performance deteriorates when PPS dispersion is too high (above the optimal level), but do not when PPS dispersion is too low (below the optimal level). These results are consistent with the notion that the inequality perceptions of some executives in an interdependent work context may hinder corporate innovation. We further find that due to adjustment costs, firms only partially close the gap between target and actual PPS dispersion over the subsequent year, and the adjustment speed is faster for firms operating in highly innovative industries. Finally, we show that deviations from optimal PPS dispersion have a negative effect on the innovation productivity of individual executives.

Keywords: team synergies, pay performance sensitivities, innovation, adjustment costs;

JEL classification: M41; M12; O31;