To date, we have only partially begun to develop an understanding of the channels through which innovation is facilitated within organizations. Although talented individuals are pivotal to supporting knowledge accumulation and renewal, they may be more willing to contribute new ideas if they expect to reap some of the gains that these ideas generate for the firm. In considering this perspective, this paper addresses whether organizational incentives affect innovation, and considers the conduits through which this link is established. In particular, this paper uses agency theory to address whether performance-based pay and performance-based promotion foster firm innovation. Our analysis relies upon a survey of 370 Brazilian manufacturing and services firms. Based on estimations of two-stage models, our results indicate that promotion is a more useful tool for encouraging innovation than pay. In addition, there seems to be a threshold above which the use of performance-based promotion is marginal.
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