Firm Lifecycles: Linking Employee Incentives and Firm Growth Dynamics

• Published date: 01 October 2017
• DOI: http://doi.org/10.1002/smj.2644
• Date: 01 October 2017
• Author: Daniel A. Levinthal,Victor M. Bennett

Strategic Management Journal

Strat. Mgmt. J.,38: 2005–2018 (2017)

Published online EarlyView 23 March 2017 in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2644

Received 2 March 2015;Final revisionreceived 2 January 2017

Firm Lifecycles: Linking Employee Incentives and Firm

Growth Dynamics

Victor M. Bennett1*and Daniel A. Levinthal2

1Fuqua School of Business, Duke University, Durham, North Carolina

2Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania

Research summary:While the economic advantages of scale are well understood, implications

of the rate of rm growth are arguably less appreciated. Since rms’ growth rate inuences

employees’ promotion opportunities, the growth rate can have signicant implications for the

incentives employees face. Rapid growth, by creating more promotion opportunities, motivates

employees to engage in extra-rolebehaviors that might result in promotion should an opportunity

arise. Building on this argument, we develop a formal model linking the design of rms’ incentive

structure to their rate of growth. The associated dynamics lead to three distinct epochs of rms’

lifecycle: rapid growth and high-powered incentives driven by frequent promotion opportunities;

moderate growth with infrequent promotion opportunities, but large salary increases contingent

on promotion; and nally, stagnant rms with low-powered incentives.

Managerial summary:While being innovative can lead to a rm growing quickly, the opposite

may also be true. Growing quickly may contribute to a rm’s ability to improve its processes.

Employees are often a source of process improving ideas. Employees’ primary incentive to go

“outside the job description” to improve those processes is often promotion. The availability

of promotions, however, is linked to the rm’s growth rate. Firms that are growing quickly can

credibly promise to reward their most innovative employees with promotions. Established and

slowly growing rms have fewer opportunities for growth, which gives employees less incentive

to go “above and beyond.” This can mean that rapid growth can reinforce a rm’s competitive

advantage. Copyright © 2017 John Wiley & Sons, Ltd.

Introduction

The Strategy literature has long appreciated the

importance of economies of scale in inuenc-

ing competitive advantage and even rm viabil-

ity (Porter, 1980). Scale economies have also been

argued to imply a positive relationship with innova-

tion (e.g., Klepper, 1996; Cohen & Klepper, 1996a,

1996b), while both popular press and some schol-

arly studies (e.g., Scherer, 1965; Zenger,1994) have

Keywords: employee incentives; rm growth; rm lifecy-

cle; process innovation; employee compensation

*Correspondence to: Victor M. Bennett, Fuqua School of Busi-

ness, 100 Fuqua Drive – Box 90120, Duke University, Durham,

NC 27708. E-mail: victor.bennett@duke.edu

Copyright © 2017 John Wiley & Sons, Ltd.

suggested that large, established enterprises may

be relatively less innovative than their younger and

faster growing competitors.1One reason for this

conict may be the conation of rm size with

rms’ growth rate. Clearly, rm scale is itself a

consequence of prior growth rates, but the con-

structs are at the same time distinct, and indeed,

empirically have been shown to be negatively

correlated (Evans, 1987). Growth is generally a

1It is important to note, however, that the Cohen and Klepper

(1996a) argument was made in the context of process innovations,

and that they were careful to treat product innovations separately

as rms might appropriate the returns from product innovations in

a qualitatively different manner, such as the introduction of new

products and services to the market, or in some cases, through the

licensing of technology to other rms.