Narrowing the pay gap: The role of government procurement

Rising income inequality is a global concern, with within-firm pay disparities between executives and employees being a significant driver. This study identifies government procurement as a potent, market-based tool to mitigate this disparity. Using data from Chinese A-share listed firms, we find that winning a government contract causally reduces the internal pay gap. Mechanism analyses reveal that this reduction is achieved primarily by compressing the excess or non-performance-sensitive component of executive compensation, facilitated by two channels: (1) the governance effect of enhanced monitoring and internal controls, and (2) the limelight effect of heightened public scrutiny. The effect is more pronounced when external monitoring by major corporate customers is weaker (i.e., a more dispersed customer base), in less-regulated industries, in regions with higher labor market pressure, and in repeated contractors. Importantly, this narrowed pay gap reflects improved efficiency, as pay-performance sensitivity increases for both executives and employees. Our findings offer novel insights for the literature on income inequality and government micro-intervention, and suggest that government procurement may provide policymakers with a viable, market-based channel for promoting pay equity.