Islands of Equality: Competition and Pay Inequality Within and Across Firm Boundaries

Abstract: How do firm boundaries affect the link between market competition and pay inequality? Using division managers as a pool of similar workers and the Canada-US Free Trade Agreement, we find that greater competition increases overall pay inequality among managers within industries, but not within firms themselves. The same pattern holds for productivity differentials between managers. Moreover, even for firms in which the differential productivity does in fact widen, we find no associated widening in pay. Internal pay equality between managers is related to higher stock returns: firms in our sample with the most equal pay outperform the market by 6-11% annually, while the most unequal firms do not. Altogether, our results suggest that, while competition leads to higher pay inequality as a whole, principals aim to maintain equality within firms and that this choice is associated with better firm performance.