There is still an ongoing debate regarding the firm performance implications of pay gaps between top executives and subordinate employees. This study integrates relative deprivation theory and tournament theory to investigate the potential nonlinear effects of pay gaps. We expect that at low levels of pay inequality, increased inequality hurts firm productivity, while at higher levels of pay inequality, increased inequality helps firm productivity. Our study of Chinese firms confirms that pay gaps have an approximately U-shaped relationship with firm performance. This nonlinear relationship is weaker in state-owned enterprises (SOEs) than in non-SOEs, suggesting that state ownership is an important moderator in the association. Overall, this study explains previous mixed findings regarding consequences of pay gaps with meaningful implications for policymakers and entrepreneurs in China and other economies with similar cultural and institutional backgrounds.

This study supports tournament theory in relation to high levels of organizational hierarchies, indicating that the job complexity facing the top management team supposes that pay dispersion positively influences firm performance. Examining a sample of 709 firm-year observations of Spanish listed companies spanning the period 2004–2012, our results indicate that the association between firm performance and top management team pay dispersion is conditional on the effectiveness of corporate governance. High top management team pay dispersion is associated with better performance in owner-controlled firms, where more effective monitoring is exerted by the board of directors.