Exploration versus Exploitation in Technology Firms: The Role of Compensation Structure for R&D Workforce

We assess the relationship between a firm’s compensation structure and its exploratory innovation. Specifically, we focus on the dispersion of a firm’s compensation structure. Drawing from compensation theories, we argue that horizontal and vertical dispersions of a firm’s compensation structure differ in their effects on R&D employees’ behavioral tendencies, which in turn are related to the exploratory innovation output of a firm. We test our argument with a 6-year panel dataset of 81 high technology firms in the U.S. We use the compensation records of 671,114 R&D personnel from 1997 to 2002 to construct pay dispersion measures for these firms in the panels and link these measures with the firms’ patent innovations filed in the U.S. We find that horizontal pay dispersion is negatively related to a firm’s exploratory innovation output, but there is no statistically significant relationship between vertical pay dispersion and exploration. In addition, the negative relationship between horizontal pay dispersion and exploration is mitigated in firms with older R&D employees on average and in firms where the age variance of R&D employees is greater.