Trust and Innovation within the Firm: Evidence from Matched CEO-Firm Data

This paper shows that CEO’s trust enhances innovation within firms, a novel micro-foundation for the well-known trust-growth relationship. I build a new matched CEO-firm-patent dataset covering 5,753 CEOs in 3,598 US public firms and 700,000 patents during 2000-2011. To identify CEO’s trust’s effect, I exploit variations in (i) generalized trust across CEOs’ ethnic origins, inferred from their last names using de-anonymized historical censuses, and (ii) CEOs’ bilateral trust towards inventors. Following CEO turnovers, a one standard deviation increase in CEO’s generalized trust is associated with 6% more future patents and 4-6% higher average patent quality. Changes in CEO’s bilateral trust towards inventors in different countries have comparable effects on inventors’ patenting, controlling for CEO and other fixed effects. Text analysis of one million employee reviews shows that CEO’s trust enhances firm’s trust culture within firms. The main effect is driven entirely by higher-quality patents, consistent with a model in which a manager’s trust incentivizes researchers to undertake high-risk explorative R&D.