Pay incentives, human capital and firm innovation in smaller firms

Abstract

This study advances the literature on human resource management in small and medium sized enterprises (SMEs) by analysing how individual and collective forms of performance-related pay (PRP) influence SMEs’ propensity for product and process innovation and how such influence varies depending on the firm’s level of human capital. We used the microdata of more than 12,000 European SMEs, controlled for endogeneity, and found that both individual (i.e. piece rate and commissions) and collective (i.e. group-bonus and profit-sharing) PRP are positively associated with higher levels of firm innovation. Interestingly, when both individual and collective PRP schemes are adopted, their association with firm innovation is significant but negative, indicating that the adoption of multiple pay incentives may be detrimental to SMEs’ innovation. Moreover, our results revealed that the effect of individual PRP on innovation is stronger in SMEs with high levels of human capital, whereas the effect of collective PRP is stronger in SMEs with low levels of human capital.