CEO compensation and innovation premium

The innovation premium of a firm is the excess market value over the shareholder expectation per a unit change in the capital stock. Using fixed effects models and cross-lagged structural equation models that address reverse causality and unobserved firm heterogeneity, we find that an increase in the innovation premium increases CEO compensation, consistent with the notion that innovation premium is shared between shareholders and managers. However, an increase in CEO compensation increases innovation premium when environmental uncertainty or firm innovativeness is high, indicating that an increase in environmental uncertainty or firm innovativeness makes the firm’s growth options more valuable, and CEOs exercise the growth options and seize the valuable growth opportunities that provide the firm the innovation premium. Our results are consistent with the managerial rent model in that the source of the innovation premium is the uncertainty associated with the innovative opportunities, which enhances the value of the firm’s growth options.