R&D expenditures and CEO compensation

This paper addresses the issue of whether firms design CEO incentives to overcome potential under-investment in R&D. Specifically, I examine the incremental association between R&D expenditures and CEO compensation above and beyond accounting earnings and stock returns. The results indicate that the incremental association between R&D expenditures and CEO compensation depends on the strength of the CEO's incentive to focus on short-term accounting earnings. That is, when CEOs have particularly strong incentives to cut R&D expenditures in order to boost accounting earnings, I find that increased R&D expenditures are associated with increased CEO compensation, primarily reflecting increased stock option grants. This association is present when the CEO is near retirement and when the firm faces an earnings decline that could potentially be reversed by reducing R&D expenditures. These findings are robust to the inclusion of governance and other control variables (e.g., CEO holdings of stock and options, and growth opportunities), treating R&D expenditures as endogenous, as well as alternative specifications and different samples of firms.; I find no evidence that firms reduce R&D expenditures when CEOs are near retirement, or when the firms have earnings declines that could be reversed by cutting R&D expenditures. This finding is consistent with firms providing CEOs with sufficient incentives to overcome potential under-investment in R&D in these two situations.; Finally, my results indicate that advertising expenditures are not related to CEO compensation, while an increase in capital expenditures leads to an increase in CEO compensation when, and only when, the CEO is near retirement. The analyses of comparing R&D, advertising and capital expenditures reveal that firms provide stronger incentives to overcome potential under-investment in R&D than in advertising and capital expenditures.