Make or Buy New Technology - a CEO Compensation Contract's Role in a Firm's Route to Innovation

Firms obtain new technology either through internal Ramp;D or through acquisitions. These two approaches are usually labeled as quot;makequot; and quot;buyquot; strategies. In this paper, I examine the relation between a firm's choice of quot;makequot; or quot;buyquot; and the performance measures used in the firm's CEO compensation contract. I focus on the two major differences between the quot;makequot; and quot;buyquot; strategies: risk levels and accounting treatment. I hypothesize that the high risk level and unfavorable accounting treatment associated with quot;makequot; strategy relative to quot;buyquot; strategy lead risk-averse managers to favor quot;buyquot; over quot;make,quot; should they be compensated heavily using accounting-based performance measures. Stock-based compensation, especially stock options, on the other hand, should encourage managers to innovate more through quot;makequot; strategies instead of quot;buyingquot; them from the outside. Using data from US high tech industries, I find evidence consistent with the above hypotheses