The knowledge-incentive tradeoff: Understanding the relationship between research and development decentralization and innovation

Abstract

Research Summary: Strategy scholars view innovation through the lens of knowledge recombination, whereas organizational economics scholars view innovation through the lens of effective incentive design. This sets up a tension regarding how firms should structure their research and development (R&D) units. Namely, decentralization facilitates the effective use of incentives but comes with the cost of reduced intra-organizational knowledge flows. In this study, I unpack this tension by examining the novelty of inventions that firms create and develop. I argue that R&D centralization facilitates the creation and development of inventions that are more novel, whereas R&D decentralization facilitates the creation of more inventions of lower average novelty and their progression through development. I find support for these arguments in the pharmaceutical industry between 1995 and 2015. Managerial Summary: When does the effective use of incentives or a firm's knowledge have a greater impact on a firm's innovation? This has important managerial implications as it shapes whether firms are better off centralizing or decentralizing their R&D units. Centralization enables firms to make better use of their knowledge and decentralization ensures the better use of incentives. More effective use of incentives associated with greater decentralization of R&D is more critical if firms wish to create and develop more inventions that are of lower average novelty. In contrast, more effective use of a firm's knowledge associated with greater centralization of R&D is more critical if firms want to create and develop a lower quantity of inventions that are of greater average novelty.