Exploration or exploitation? A study on equity incentive design, dynamic decision making, and economic consequences

We examine whether equity incentive can encourage exploratory innovation from the perspective of dynamic innovation decision-making process. Using the data of equity incentives in China’s listed companies from 2006 to 2017, we construct exploratory intensity of innovation strategy and analyze the impact of equity incentive on corporation exploratory innovation strategy from both the cross-sectional and time-series perspectives. We find a positive relationship between the vesting period and explorative innovation strategy in the cross-sectional dimension. However, the time-series analyses show that the innovation strategy becomes less explorative and more exploitative after the third period during equity incentive. The effect of vesting period is stronger in smaller firms and during the non-financial crisis period. Further analysis reveals that followed by the changes in innovation strategy, the growth rates of innovation output and firm performance also decline.