Building firm capability: managerial incentives for top performance

Purpose: This paper aims to present a model of how incentives enhance competitive advantage by improving the sourcing, development and leveraging of firm capabilities. Design/methodology/approach: 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. Findings: 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. Practical implications: The model is useful for focusing executives on how incentives impact the development of firm capabilities, which are at the core of competitive advantage. Originality/value: 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.