The rising pay inequality between CEO and rank and file employees has attracted considerable attention from the public, activists, regulators, and academic researchers. High CEO pay may incentivize employees to work hard for promotions and/or can help a firm attract talented CEO. Alternatively, high CEO pay may lead to inequity aversion and decrease employees’ work effort and/or signal rent extraction. We employ an advanced DuPont return on assets (ROA) decomposition to empirically test the predictions of these competing theories about the effects of pay inequality on firm performance. Using a sample of 1,321 Indian firms during 2017-2019 period, we find that pay inequality leads to better future performance as measured by the ROA, providing prima facie support for tournaments and talent assignment. However, an analysis of drivers of ROA reveals that the source of ROA improvement is better asset utilization (ATO). Further decomposition of ATO reveals that pay inequality leads to a significant decrease in labor productivity consistent with inequity aversion. Labor intensity increases significantly and is the sole driver of gains in asset utilization that in turn leads to ROA improvement. In other words, the observed improvements in ROA are simply the result of hiring more employees. Although it makes sense to hire more employees in an economy with low labor costs, it is hard to see as a reflection of executive talent.