The Double-Edged Sword of Pay-for-Performance: Implications for Organisational Capital and Innovation

The study examines how executive incentive design shapes firms’ investments in organisational capital and the resulting consequences for innovation and firm value. Integrating agency theory, managerial myopia, the resource-based view, and the complementary-assets perspective, we argue that pay-for-performance sensitivity (PPS) exerts a nonlinear influence on organisational capital. Using panel data for S&P 1500 firms from 2006–2020 and multiple approaches that address endogeneity—including firm fixed effects, system GMM, cross-lagged structural equation models, and augmented inverse-probability weighted estimators—we find an inverted U-shaped relationship between PPS and organisational capital. Moderate incentive intensity encourages capability accumulation, whereas excessive incentive intensity induces managerial short-termism and reduces investment in organisational capital. We further show that organisational capital positively affects firm value, although this benefit diminishes under high PPS, and that organisational capital complements corporate R&D by increasing firms’ ability to convert innovation investments into market value. These findings reconcile competing theories of executive incentives while identifying organisational capital as the strategic mechanism linking compensation design to long-term innovation performance.