The knowledge‐incentive tradeoff: Understanding the relationship between research and development decentralization and innovation

Research Summary Strategy scholars view innovation through the lens of knowledge recombination, whereas organizational economics scholars view innovation through the lens of effective incentive design. This sets up a tension regarding how firms should structure their research and development (R&D) units. Namely, decentralization facilitates the effective use of incentives but comes with the cost of reduced intra‐organizational knowledge flows. In this study, I unpack this tension by examining the novelty of inventions that firms create and develop. I argue that R&D centralization facilitates the creation and development of inventions that are more novel, whereas R&D decentralization facilitates the creation of more inventions of lower average novelty and their progression through development. I find support for these arguments in the pharmaceutical industry between 1995 and 2015. Managerial Summary When does the effective use of incentives or a firm's knowledge have a greater impact on a firm's innovation? This has important managerial implications as it shapes whether firms are better off centralizing or decentralizing their R&D units. Centralization enables firms to make better use of their knowledge and decentralization ensures the better use of incentives. More effective use of incentives associated with greater decentralization of R&D is more critical if firms wish to create and develop more inventions that are of lower average novelty. In contrast, more effective use of a firm's knowledge associated with greater centralization of R&D is more critical if firms want to create and develop a lower quantity of inventions that are of greater average novelty.