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Although the pay gap between executives and employees has received considerable attention, its economic consequences remain unclear due to the unavailability of data. In this study, we examine the effects of the pay gap on firm innovation by using data from Chinese listed firms. We show that: 1) the first-order effect of pay gap on firm innovation is significantly positive, supporting the tournament theory; 2) however, when pay gap is relatively high, the importance of comparison theories increases; 3) high management pay premiums provide incentives for management to devote to innovation activities, while pay premiums for ordinary employees impede firm innovation; and 4) both the employee's human capital and state ownership play significant roles in the negative effects of employee pay premiums on firm innovation. Overall, we provide critical insights and a serious challenge for regulators in China.The policy implications of this study could be of interest to regulators who intend to encourage firm innovation.

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Using a unique dataset from National Bureau of Statistics of China, we estimate the total factor productivity (TFP) of enterprise and explore the relationship among research and development expenditures (R&D), financial constraints and TFP. We find that: First, R&D has a significantly lagged effect on the improvement of TFP. Second, the R&D fails to improve the contemporaneous productivity and negatively impacts on contemporaneous TFP. Third, financial constraints significantly reduce the improvement effect of R&D on TFP, and this kind of marginal effect has significant difference between state-owned enterprises (SOEs) and private enterprises (Non-SOEs). This study offers important policy implications by showing that: First, firms can obtain long-term benefits from continuous R&D expenditures. Second, the government should release appropriate policies to ease financial constraints, especially for the Non-SOEs.

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