We investigate the effect of profit sharing on product and process innovation. The general aim of companies introducing profit sharing in their remuneration policy is to stimulate staff performance. As profit maximization becomes a win-win strategy to both the employees and the firm owners, their mutual interests become aligned. If the incentive system works in an efficient way and if employees behave rationally, they will increase their efforts, which should subsequently raise the company's performance.
While many studies consider the effects of profit sharing on firm performance in general (productivity, profitability), not much is known about the effects on innovation. In this paper, we introduce measures of technological progress in an attempt to unravel how profit sharing may interact with firm performance through the realisation of both product and process innovations. We employ the IAB establishment panel, an extensive dataset on German establishments over the time periods 2005 to 2009. In order to eliminate possible selectivity effects, we apply static matching and conditional difference-in-differences methods.
Based on the matching results, profit sharing companies outperform non-profit sharing companies on both process and product innovativeness. However, according to the results of the conditional difference-in-differences method only product innovation is enhanced by the introduction of profit sharing. Hence firms introducing profit sharing are already more innovative with respect to both product and process innovations before they launch the variable incentive method of profit sharing. But profit sharing additionally has a positive effect on product innovations.