Does Pay Gap Incentivize Total Factor Productivity? Evidence from China with Policy Implications

Total factor productivity (TFP) refers to the increased efficiency in production achieved while maintaining a given level of various factor inputs. Using the listed firms in China, this study explores the effect of pay gap on corporate TFP. We find, first, the pay gap within firms incentivize corporate TFP, as evidenced by several robust tests. Second, the corporate innovation and internal control are the economic channels through which the pay gap incentivize TFP. Additionally, the motivating effect of the pay gap is more pronounced in non-SOEs, firms operating in high-technology industries, firms located in the eastern economic district, companies with limited development prospects, high financing constraints, and weak corporate governance. Overall, this study provides further evidence of tournament effects resulting from pay disparity and highlights a novel driving factor for corporate total factor productivity in emerging markets.