Make Or Buy Analisis

Make or buy new technology:

The role of CEO compensation contract in a firm’s route to innovation

Article Review / Critique

Yanfeng, Xue., Rev Acc St (2007). Make or buy new technology: The role of CEO compensation contract in a firm’s route to innovation. Journal of Mergers and acquisitions, Compensation and Technology, 12, 659–690.

This paper examines whether a firm’s board aligns the CEO compensation contract with the management strategy choices for obtaining new technology. Companies can obtain new technology either through in- house research and development or through external acquisitions and licensing. These two approaches to acquiring new technology are often labeled as ‘‘make’’ and ‘‘buy’’ strategies and studies whether the choice of performance measures used in executive compensation contracts can affect managers’ choice between the ‘‘make’’ and ‘‘buy’’ strategies. (Yanfeng, 2007).

To develop a testable hypothesis the author focuses on the two major differences between make or buy strategies and implications for risk managers. In this sense, innovative managers prefer to buy rather than make. The author instead of focusing on single innovation strategies, examines the impact of managerial incentives on a firm’s choice between multiple innovation strategies for improving acquisitions of IT resources. Also provides direct evidence that the use of accounting information in contracting can affect firms’ real operating and investment decisions.

The author develops his hypothesis by analyzing the relationship between a firm’s CEO compensation contract and investment decision-making process; describes the research design; presents the factors other than compensation that could affect a firm’s choice between ‘‘make’’ and ‘‘buy’’ strategies and that should be controlled in the regression analyses. The sample selection and summary statistics presents the empirical results and offers the concluding remarks.

The empirical results of this study based on the correlation coefficient provide that is significantly negative, indicating that more accounting-based compensation tends to encourage technology acquisition activities and depress Research and Development intensity. The findings indicate that the risk-seeking incentives from stock-based pay are important in motivating managers to obtain technology from ‘‘make’’ instead of ‘‘buy’’ approaches. The empirical results indicate that risk-seeking incentives provided by stock-based compensation encourage a firm to obtain new technology through Research and Development investment instead of purchasing it from the outside.

In conclusion is that the various types of incentive compensation play very different roles in determining managers’ approach to innovation. CEOs receiving relatively more accounting- based compensation tend to

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