Trust and Innovation Within the Firm

This paper investigates whether and how a CEO’s inherited generalized trust enhances innovation within firms, offering a micro-foundation for the well-documented macro-level relationship between societal trust and economic growth. The author argues that trust — by inducing tolerance of failure — encourages researchers to undertake high-risk, explorative R&D rather than safe exploitation of known approaches.

The empirical foundation is a matched CEO-firm-patent dataset covering 5,753 CEOs at 3,598 US public firms during 2000–2011, encompassing 700,000 patents and over one million inventors. CEO trust is measured as an inherited trait: each CEO’s ethnic origin is inferred probabilistically from their last name using de-anonymized US censuses from 1910–1940, and ethnic-origin-specific trust levels are drawn from the US General Social Survey (GSS), restricted to respondents in highly prestigious occupations. The resulting trust measure is the weighted average of ethnic-specific trust scores across a CEO’s likely ethnic composition.

The main empirical strategy exploits within-firm variation across CEO transitions, using firm and year fixed effects to compare patenting before and after a CEO change. The identifying assumption — that the timing of CEO transitions and the new CEO’s trust level are not predicted by prior firm patenting trends — is supported by event-study tests showing flat pre-trends. A one-standard-deviation increase in CEO inherited generalized trust (equivalent to the difference between Greek and English averages) is associated with a 6.2–6.3% increase in patent filings, statistically significant at the 1% level. For the average firm, this equals approximately 1.1 additional patents annually, worth roughly $6.8 million. The effect is larger among exogenous transitions (CEO retirement or death): 8.5% in the restricted sample, and an IV estimate of 8.2%. The back-of-envelope calculation suggests this trust-innovation channel could account for approximately 37% (range: 16–58%) of the effect of trust on GDP per capita growth.

The paper’s central mechanism — risk taking — is tested by examining the distribution of patent quality rather than the mean. Under the risk-taking mechanism, trust should increase the variance of R&D project quality, raising high-quality patents without necessarily increasing low-quality ones. Consistent with this, CEO trust raises only above-median quality patents (measured by forward citation decile), with effects increasing monotonically toward the top decile and no statistically significant effect on below-median patents. Average patent quality as measured by citation-weighted counts or patent value rises by 4–6%. Trust also disproportionately raises the share of explorative patents (those with at least 90% of backward citations outside the firm’s existing knowledge stock) by 1 percentage point over a base of 17%.

The transmission channel is examined using BERT-based classification of nearly one million Glassdoor employee reviews. Under more trusting CEOs, firms exhibit stronger top-down trust sentiment (managers trusting workers), particularly among R&D workers and scientists. The effect materializes within the first two years of a CEO term. Director selection provides an additional transmission mechanism: under more trusting CEOs, newly appointed directors are more trusting and departing directors are less trusting.

A within-CEO design using bilateral trust (toward researchers in specific countries) with CEO fixed effects addresses omitted CEO characteristics. A one-standard-deviation increase in CEO bilateral trust toward a country is associated with a 5% increase in patents by inventors in that country’s R&D lab, controlling for firm-by-year, CEO, and inventor-country fixed effects.

The effect is strongest when CEO trust is matched to a high-quality researcher pool; in firms with mostly low-quality researchers, high trust may be counterproductive. Trust is also a substitute for R&D knowledge: the effect disappears when the CEO holds a non-MBA graduate degree or has prior R&D experience.

Q: What is the main research question? A: The paper asks whether a CEO’s generalized trust causes more and higher-quality innovation within the firm, and through what mechanism. It also asks how trust transmits from the CEO to researchers who rarely interact with the CEO directly.

Q: How is CEO trust measured? A: CEO trust is measured as an inherited trait using a two-step procedure. First, each CEO’s last name is probabilistically mapped to one or more ethnic origins using four de-anonymized US censuses (1910–1940). Second, ethnic-origin-specific trust is computed from GSS respondents in highly prestigious occupations. The CEO’s trust measure is the weighted average across ethnic compositions. This measure is shown to be more precise than an individual-level survey measure and approximately 80% as precise as a game-based measure, without introducing attenuation bias.

Q: What is the baseline patent effect and how large is it economically? A: A one-standard-deviation increase in CEO inherited trust is associated with a 6.2–6.3% increase in patent filings (statistically significant at 1%). For the average baseline firm, this is approximately 1.1 additional patents per year, valued at roughly $6.8 million. When patent quality is accounted for, the effect rises to 9.9% using citation-weighted patent count and 11.5% using patent value based on excess stock returns on grant dates.

Q: Is the effect causal? What identification strategy is used? A: The main strategy uses firm and year fixed effects, identifying the effect from within-firm variation around CEO transitions. Pre-trend tests confirm that neither the timing of CEO changes nor the new CEO’s trust level predicts prior firm patenting. Among exogenous transitions (CEO retirements and deaths), the effect is 8.5%, and an IV estimate using the predecessor’s trust as instrument yields 8.2% (significant at 10%), both comparable to the baseline.

Q: What is the macroeconomic significance of the trust-innovation channel? A: Combining the paper’s trust-to-patents estimate (0.042–0.062) with Akcigit et al.’s (2017) patents-to-GDP-growth estimate (0.026–0.066) and the cross-country trust-to-growth coefficient (0.007), the trust-innovation channel could explain approximately 37% of the effect of trust on growth, with a plausible range of 16–58%.

Q: What is the mechanism linking CEO trust to innovation? A: The conceptual mechanism is that a more trusting manager interprets researcher failure as bad luck rather than bad type, making her more likely to tolerate failure and continue employing the researcher. This increases the researcher’s incentive to pursue explorative, high-risk R&D over safe exploitation of known approaches. The mechanism implies a variance-increasing effect on the R&D quality distribution, rather than a mean shift.

Q: How is the risk-taking mechanism tested against alternative mechanisms? A: The paper examines the distribution of patent quality by citation decile. Under mean-shifting alternatives (delegation, cooperation, relational contracting), trust should raise all quality brackets. Under risk-taking, trust raises only high-quality patents. The results show CEO trust has monotonically increasing effects from low to high quality deciles, with no statistically significant effect on below-median patents, consistent only with the variance-increasing (risk-taking) mechanism.

Q: What patent quality measures are used and what do they show? A: Beyond forward citation deciles, the paper uses explorativeness (patents with at least 90% of backward citations outside the firm’s existing knowledge stock), disruptiveness (Funk and Owen-Smith, 2017), patent importance (Kelly et al., 2021), backward citations to scientific literature, and patent scope. Trust increases all these measures with statistically significant positive coefficients. The share of explorative patents rises by 1 percentage point over a base of 17%. Average citation count and patent value increase by 4–6%.

Q: Does CEO trust raise R&D expenditure? A: No. The coefficients from regressing R&D expenditure on CEO trust are neither statistically significant nor large enough to explain the innovation effect. The patent effect is also robust to controlling for R&D inputs, suggesting that trust affects the type of projects chosen (consistent with risk-taking) or their realized outcomes, rather than the scale of R&D.

Q: How does CEO trust transmit to corporate culture? A: Using BERT-based classification of nearly one million Glassdoor reviews covering 266 firms and 397 CEO terms between 2008 and 2017, the paper finds that CEO trust is associated with stronger top-down trust sentiment (managers trusting workers). The normalized effect of a one-standard-deviation increase in CEO trust on overall trust sentiment is 0.257, on top-down trust 0.531, and on bottom-up trust only 0.141 (statistically insignificant). The effect is strongest among reviewers who identify as scientists, researchers, or engineers, and materializes within the first two years of the CEO term.

Q: What evidence exists for transmission via director selection? A: Under more trusting CEOs, newly appointed directors — especially those who remain until the end of the CEO term — are more trusting, and departing directors are less trusting. The average director trust improves during the CEO’s term. Because 54% of director hirings and 46% of turnovers occur within the first two years, this change also materializes quickly, consistent with the dynamic pattern of trust culture change.

Q: What is the within-CEO bilateral trust result and what does it add? A: Using within-CEO variation in bilateral trust toward researchers from different countries (from Eurobarometer surveys), and controlling for CEO, inventor-country, and firm-by-year fixed effects, a one-standard-deviation increase in CEO bilateral trust toward a country is associated with a 5% increase in patents by inventors in that country’s R&D lab. This design allows CEO fixed effects, ruling out unobserved CEO-level confounders such as management style or R&D ability.

Q: When is CEO trust counterproductive? A: CEO trust is beneficial only when matched to a high-quality researcher environment. Using residual patent output (controlling for observable firm and CEO characteristics) as a proxy for researcher quality, the effect of CEO trust on patents, patent output per R&D dollar, and future sales/employment/TFP is significant only among firms in the top two quintiles of researcher quality. In firms with mostly low-quality researchers, high CEO trust may be counterproductive by failing to screen out bad researchers.

Q: How does the trust effect vary by industry and CEO background? A: The effect is ubiquitous across industries but especially pronounced in pharmaceutical and ICT firms. The timing varies: it manifests quickly in ICT (short R&D lag) and more slowly in pharma (long R&D horizon). The effect vanishes when the CEO holds a non-MBA graduate degree or has prior R&D experience, suggesting trust is a substitute for direct knowledge of R&D processes.

Q: Are the results robust? A: Yes. The paper reports 14 categories of robustness checks including alternative patent transformations, alternative trust measures (LASSO, World Value Survey, Global Preference Survey, alternative GSS questions), alternative standard error clustering, Poisson count models, restriction to granted patents, exogenous transition subsamples, modern difference-in-differences estimators (de Chaisemartin et al., 2024; Sun and Abraham, 2021; Callaway and Sant’Anna, 2021; Borusyak et al., 2024), and leave-one-ethnicity-out. The baseline result is stable across all these checks.

Inherited generalized trust: The paper’s measure of a CEO’s trust disposition, defined as the probability-weighted average of ethnic-origin-specific trust levels (from the GSS) based on the CEO’s likely ethnic composition inferred from their last name and historical census records. It captures the culturally transmitted component of trust, distinct from individual-level noise.

Explorative R&D: In the paper’s framework (building on March, 1991), research activities that involve testing untested paths, carrying high risk of failure but high potential for innovation, as opposed to exploitation of well-known approaches with low failure risk. The paper argues CEO trust encourages researchers to shift toward exploration.

Tolerance of failure: A manager’s propensity to attribute a researcher’s failure to bad luck rather than bad type. Under the paper’s mechanism, a more trusting manager gives greater weight to bad luck, making her more likely to retain the researcher after failure, thereby incentivizing risk taking.

Top-down trust: In the paper’s BERT-based classification of Glassdoor reviews, the direction of trust from managers toward workers (as opposed to bottom-up trust from workers toward managers). The paper finds CEO trust primarily raises top-down trust sentiment, especially among R&D workers.

Patent explorativeness: A patent quality measure defined as the share of its backward citations that fall outside the firm’s existing knowledge stock; patents are classified as explorative if at least 90% of backward citations are outside that stock. The paper uses this as a direct measure of explorative R&D output.

Bilateral trust: CEO d’s directed trust toward individuals from country c, computed analogously to inherited generalized trust but using Eurobarometer survey data on country-pair trust attitudes among European-origin populations. Used in the within-CEO design to control for CEO fixed effects.

Variance-increasing mechanism: The paper’s characterization of the risk-taking channel, in which CEO trust raises the variance (not the mean) of the R&D project quality distribution by encouraging researchers to pursue high-risk, high-reward exploration. Empirically identified by the pattern that trust raises only above-median quality patents with monotonically increasing effects toward the top decile.