Motivating innovation is an important concern in many organizations.
For example, shareholders of large corporations often need to motivate managers to pursue more innovative business strategies. Managers often complain that it is hard to induce their employees to be more
Gustavo Manso from the University of California at Berkeley studies how to structure incentives when the principal (manager) needs to motivate the agent (employee) to be more innovative?
He shows that the optimal incentive scheme that motivates innovation exhibits substantial tolerance (or even reward) for early failure and reward for long-term success.
By using a class of Bayesian decision models known as bandit problems he finds that commitment to a long-term compensation plan, job security, and timely feedback on performance can become essential ingredients to motivate innovation. In the context of managerial compensation, the optimal incentive scheme that motivates innovation can be implemented via a combination of stock options with long vesting periods, option repricing, golden parachutes, and managerial entrenchment.
Reference: Manso, G. (2011). Motivating innovation. The Journal of Finance, 66(5), 1823-1860.