Trust and Innovation Within the Firm: Evidence from Matched Ceo-firm Data

Kieu-Trang Nguyen (London School of Economics)

Abstract: This paper provides evidence on the effect of trust on innovation within firms. I build a new matched CEO-firm-patent dataset covering 5,753 CEOs in 3,598 large US public firms and 700,000 patents during 2000-2011. To identify the effect of CEO's trust, I exploit variation in generalized trust across the countries of CEOs' ancestry, inferred from their last names using de-anonymized historical censuses, as well as variation in CEOs' bilateral trust towards inventors. First, one standard deviation increase in CEO's generalized trust following a CEO turnover is associated with over 6% increase in firm’s future patents. Second, changes in CEO's bilateral trust towards inventors in different countries (i.e., different R&D labs within multinational firms) or from different ethnic origins in the same firm have comparable effects on inventors' patenting, controlling for CEO and other stringent fixed effects. Trust-induced improvements in innovation are driven entirely by higher-quality patents, consistent with a model in which CEO’s trust incentivizes researchers to undertake high-risk explorative R&D. Finally, I show that across and within firms, CEO's generalized trust is strongly correlated with a broader corporate culture of trust, as measured from the text analysis of one million online employee reviews. The evidence provides a micro-foundation for the well-known macro relationship between trust and growth.

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