Relative pay and its effects on firm efficiency in a transitional economy

•We examine relative pay in China, which previously espoused equality in pay.•We find a wide pay difference in compensation for top management and the average worker.•The wide pay differences have a detrimental effect on a firm's productivity.•The detrimental effect is most pronounced in labor-intensive firms.

In this study, we examine the impact of relative pay (manager pay divided by average worker pay) on a firm's productivity. Using data from a major transitional economy, China, we find that relative pay is negatively associated with high productivity. Our results provide support for the view that workers are alienated when their incomes are far lower than that of top management and this leads to lower productivity. This effect is most pronounced in labor intensive firms.