Prior research that focuses on the impact of the CEO–TMT vertical pay gap on firm performance has largely yielded equivocal findings. We address the equivocal findings by examining firm productivity, a more immediate reflection of TMT members’ effort motivated by the CEO–TMT vertical pay gap. Drawing on tournament theory, we theorize that the increased CEO–TMT vertical pay gap will lead to higher firm productivity. We also contend that the positive relationship will be stronger when firms are headquartered in states with high noncompete enforceability and weaker when CEOs are outsiders. Using data from US public firms from 1993 to 2012, we find broad support for our hypotheses. Our study advances the scholarly understanding of tournament incentives in the form of the CEO–TMT vertical pay gap and provides practical implications on how boards of directors can incorporate tournament incentives into the design of executive compensation.