Does CEO Pay Disparity Enhance or Impede Innovation Performance?

This paper examines the effects of CEO pay disparity on firm innovation. We discuss three streams of theories to develop hypotheses that may capture the empirical observations about the relationship: entrenchment, tournament, and excess outcome hypotheses. To investigate whether CEO pay disparity enhances or impedes innovation performance, we use CEO pay slice (CPS) and patent citation counts as proxies for CEO pay disparity among the top management team and innovation respectively. Using a two-stage least squares regression approach, we find that patent citations are positively associated with CPS. The finding supports the tournament argument that CEO pay disparity represents the size of the grand prize awarded to the winner of a tournament at the final stage of hierarchical advancement in an organization and increases the organizationwide incentives toward firm performance. We confirm that the results are robust to endogeneity issues, additional tests using alternative measures for pay disparity and innovation, and subsamples of firms which are more technology-intense and innovation-driven.