Equity-Based Incentives and Collaboration in the Modern Multibusiness Firm

Abstract

This paper examines the role of equity-based incentives in fostering cross-business-unit collaboration in multibusiness firms. We develop a formal agency model in which headquarters offers equity and profit incentives to business-unit managers with the objective of maximizing total expected firm returns. The resulting compensation contract provides a rich mechanism for aggregating value from collaborative interactions across business units, aligning managers’ efforts with the firm’s growth prospects and organization structure, and managing the dual risk in profits and firm market value. The inclusion of equity incentives elicits higher levels of own-unit and collaborative efforts over the profits-only contract. Our results suggest that equity-based incentives are most beneficial when profitability is uncertain relative to long-term growth prospects, in firms pursuing related diversification strategies, and in periods of rising equity markets.

Keywords: multibusiness firms, collaboration, equity and profit incentives, organizational design, total firm returns

JEL Classification: D2, L2, G3, D8, J3, J42