Economic theory suggests that managers’ investment behavior differs from that of owners. On the one hand, managers might under-invest into R&D compared to owners for reasons of risk. R&D projects are typically risky, long-term investments with a high failure rate. Because project failure can have detrimental effects on a manager’s career and eventually lead to job loss, managers might under-invest into R&D projects. On the other hand, managers might over-invest into R&D compared to owners for reasons of growth. Innovation fosters growth, which is found to go along with greater managerial remuneration, power and prestige. In reality, however, the concept of manager-led versus owner-led firms turns out to be fuzzy, as many managers frequently own shares of their firms. Therefore, the literature discusses incentive effects and entrenchment effects. With an increasing amount of company shares held by the manager, his behavior becomes more aligned to the owners interest (incentive effect). But at the same time ownership shares also result in higher job security for the manager and, hence, make him powerful enough to pursue own goals and disregard owners’ interests (entrenchment effect). In this study, we investigate empirically whether managerial ownership affects a firm’s R&D expenditure using a sample of 1,406 Belgian firms. First, we find that managers holding no company shares under-invest into innovation when compared to owners giving rise to the risk argument. These managers seem to have insufficient incentives to invest into R&D, as they fear that project failure could negatively affect their careers. Second, we find an inverse ushape relationship between the degree of managerial ownership and R&D expenditure. This indicates that managers become entrenched when holding a sufficient amount of company shares. Higher job security allows the managers to pursue their own interests, i.e. to overinvest into innovation for reasons of growth. Due to their ownership shares managers do not have to fear detrimental effects on their career in case of project failure. This reduces the risk tied to R&D investments while the positive aspects remain.

Köhler, Mila, Dirk Czarnitzki and Kornelius Kraft (2011), Managerial Ownership, Entrenchment and Innovation, ZEW Discussion Paper No. 11-026, Mannheim, published in: Economics of Innovation and New Technology. Download


Corporate governance, managerial ownership, entrenchment, innovation, R&D investments