Do incentives work? Option-based compensation and corporate innovation

Numerous scholars have investigated the link between option-based compensation and innovation in public firms, generally concluding options motivate innovative activities better than alternative compensation methods. In most studies, the evidence of causality is weak or suffers from econometric concerns, leading to questions regarding the conclusions. We use the implementation of FAS 123R as a quasi-natural experiment to explore the role option compensation has in incentivizing innovation. FAS 123R increased the cost of granting options as compensation, resulting in a plausibly exogenous shift away from options. Using an updated sample of patent applications, we do not observe any decline in innovation. Despite a similar empirical design, our results differ from those of Mao and Zhang (2018), due to truncation bias inherent in their patent data. Overall, using our updated data, our findings are inconsistent with conclusions from prior studies and suggest option-based compensation does not drive innovation.