Monetary incentives and innovation in Chinese SMEs

We investigate the impact of monetary incentives on the innovation performance of a unique sample of private Chinese SMEs. Building on an agency-theoretic framework, we find evidence that firm-specific incentives matter, but their impact is contingent on the nature of the incentive, the employees at whom it is directed, and the measure of innovation employed. However, contrary to our hypothesis and the evidence in other countries, we find that pay-for-performance measures for managers positively impact patenting activity. This result is inconsistent with agency theory and reflects the Chinese institutional environment, notably state incentives for innovation.