Curb Your Innovation: On the Relationship Between Innovation and Governance Structure

Abstract

In this paper, we analyze the relationship between innovation and firms’ governance structure. We present and analyze a simple model in which the firm’s governance struc- ture influences the behavior of innovative employees and, in turn, innovation brings about changes to the firm’s governance structure. Central to our analysis is the notion that power and rent sharing are reassessed when new ideas are implemented. The new rent allocation is determined by the ex-post bargaining power of all players involved in the new project. We highlight two problems that the owners of firms face in these situations. First, the tendency of owners to expropriate the rents of innovators often leads innovators to leave firms before revealing their ideas internally. Second, the fear of intra-firm rent redistribution brought about by innovation often results in conserva-tive attitudes among the firm owners. After illustrating how our model captures these two problems, we disscuss how alternative decision-making protocols, such as delegat-ing authority to a CEO or decentralizing the decision-making process of the firm, can help to mitigate them. These results are consistent with patterns of innovation and governance observed in the high-tech industry.