Abstract
This study examines the effects of pay inequality within the top management team on firm innovation, which is considered a key driver for long-term firm performance and value. We discuss the competing theories of social comparison and tournament to develop hypotheses regarding the effects of pay disparity on innovation. Using the 12,762 firm-year observations from U.S. firms, we find that patent citations are negatively associated with pay disparity after controlling for a CEO's pay level and power. The results are robust to additional tests using a set of alternate measures of pay disparity and innovation, a subsample of patenting-active firms, an instrumental variable approach, and a matched sample analysis. The findings support the behavioral perspective that a large pay disparity is detrimental to cooperation among executives, which is essential for successful innovation processes. Our findings will be of interest to policymakers in the ongoing policy debate on pay inequality on firm operations.
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