Executive pay restrictions and R&D investment

In response to the debate on restricting executive compensation, this study investigates the impact of executive pay caps on investments in research and development (R&D). Exploiting the 2014 pay restriction scheme for SOEs in China as a natural experiment, we find that R&D investment in SOEs grow slower than in non-SOEs following the scheme's implementation, with the effect mainly observed in the expensed component of R&D. Consequently, SOEs experience a decrease in innovation quality and firm value after the executive pay restriction is imposed. Reflecting the role of political advancement as a substitutive incentive device in SOEs, we find the negative impacts of the pay restriction are lessened by political promotion incentives. Overall, our findings suggest policymakers should be cautious when implementing restrictive pay policies, as it may reduce executives' incentive to pursue innovation efforts.