Corporate Conservatism and Relative Compensation

This paper demonstrates that, in a simple setting with managerial concern for reputation and asymmetric information on ability, most managers may refrain from undertaking innovations that stochastically dominate an industry standard. Common components of uncertainty lead to market inferences of managerial ability based on relative performance. Managers who undertake the industry standard are consequently evaluated with a more accurate benchmark than those innovating. Discontinuities in compensation when performance is low lead managers to have differing valuations of an accurate benchmark, depending on type. In particular, very high and very low ability managers are more likely to undertake superior innovations than those of average ability.