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Due to the importance and challenges, the issue of innovation has been a major one for decades in academia. In this paper, we investigate the effect that stock options have on radical and incremental innovation performance. We conclude that nonexecutive options have a significantly positive effect on both radical and incremental innovation, whereas executive options are only related to incremental innovation. The association between executive options and incremental innovation is more pronounced in firms with weaker free-rider problem and lower diversification, whereas the positive correlation between nonexecutive options and innovation is not magnified or weakened significantly by free-rider problem or firm diversification. Further analysis reveals that nonexecutive options foster radical innovation success through risk-taking and performance-based incentives, whereas executive options (nonexecutive options) contribute to incremental innovation success mainly through risk-taking (performance-based) incentives. We also determine that the distribution structure of a firm’s options matters. Collectively, our evidence shows that nonexecutive options facilitate better innovation performance, and rank-and-file employees are better innovators in a company.

Radical or incremental: which type of innovation do stock options drive?