A growing number of Chinese firms motivate their employees through employee stock ownership plans (ESOPs). Using a sample of listed firms in China, this paper examines the impact of ESOPs on firms’ total factor productivity (TFP), as well as the mechanisms of ESOPs. The empirical results show that ESOPs have a positive impact on firm TFP. The mechanism tests convey that ESOPs increase firm TFP by promoting research and development (R&D) investment and mitigating agency costs. These results are robust after accounting for endogeneity and using alternative metrics of TFP. In addition, we find that the positive effect of ESOPs on firm TFP is more pronounced in non-state-owned firms and firms with a less severe free-riding problem. Furthermore, the effect on firm TFP is positively associated with the subscription proportion of non-executive employees in ESOPs. Overall, the results of this study underscore the important role of employee ownership in firms’ productivity improvement.
