Building firm capability: managerial incentives for top performance

This paper aims to present a model of how incentives enhance competitive advantage by improving the sourcing, development and leveraging of firm capabilities.

The author first reviews the key findings of prominent academic and managerial papers on capability building and incentives. The author then proposes a model that advances our understanding of how incentives affect competitive advantage through capability building. The author applies this model to the empirical setting of private equity, where buyouts – by adopting the “carrot and stick” approach – improve the alignment of managerial and firm interests and, in turn, encourage capability building.

The model shows how incentives act on capabilities in three areas: the leveraging of existing capabilities, the sourcing of capabilities internally and the sourcing of capabilities externally.

The model is useful for focusing executives on how incentives impact the development of firm capabilities, which are at the core of competitive advantage.

This paper expands on existing literature by providing a model linking incentives to the competitive advantage of the firm. The model will encourage new ways of thinking about incentive programs, casting them as a method for developing firm capabilities and thereby sustaining firms’ competitive advantage.