Top manager ownership levels and incentive alignment in inventively active firms

Purpose – Firms that pursue invention face special conditions that heighten the potential conflict between managers and shareholders. High R&D spending increases the information asymmetry between managers and shareholders because the invention process is rooted in tacit knowledge. Because tacit knowledge is difficult to communicate to external parties, shareholders will have problems monitoring whether managers are spending R&D in a manner that maximizes firm value. Design/methodology/approach – Using agency theory, it is argued that managerial ownership is one solution to this problem and that high levels of R&D intensity will necessitate high levels of managerial ownership to counteract agency problems. However, it is also argued based on signaling theory that a firm's patenting activity reduces ownership requirement as well as moderating the managerial ownership‐R&D relationship. Findings – Using a sample of firms from the knowledge‐intensive biotechnology industry, a positive relationship was found between R&D spending and managerial ownership. It was also found that this relationship is most strongly moderated by patenting activity. Research limitations/implications – The findings would be strengthened by replication using samples from other knowledge‐intensive industries. Future research should examine how the critical determinants of success in other industries affect managerial ownership of firms in those industries. Practical implications – The study shows that top managers have some control over the contracting environment. By aggressively pursuing patents managers can reduce their level of ownership in the firm. Originality/value – The study finds evidence that in order to prevent agency problems firms undertaking inventive activity may require their managers to take larger ownership or aggressively pursue patents. High managerial ownership levels and patents can provide a signal to shareholders about the growth potential of the firm.