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«IZA DP No. 4262 PAPER Gift Exchange and Workers’ Fairness Concerns: When Equality Is Unfair Johannes Abeler DISCUSSION Steffen Altmann Sebastian ...»

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SERIES

IZA DP No. 4262

PAPER

Gift Exchange and Workers’ Fairness Concerns:

When Equality Is Unfair

Johannes Abeler

DISCUSSION

Steffen Altmann

Sebastian Kube

Matthias Wibral

June 2009

Forschungsinstitut

zur Zukunft der Arbeit

Institute for the Study

of Labor

Gift Exchange and Workers’ Fairness

Concerns: When Equality Is Unfair

Johannes Abeler

University of Bonn and IZA Steffen Altmann IZA and University of Bonn Sebastian Kube Max Planck Institute for Research on Collective Goods, University of Bonn and IZA Matthias Wibral University of Bonn and IZA Discussion Paper No. 4262 June 2009 IZA P.O. Box 7240 53072 Bonn Germany Phone: +49-228-3894-0 Fax: +49-228-3894-180 E-mail: iza@iza.org Any opinions expressed here are those of the author(s) and not those of IZA. Research published in this series may include views on policy, but the institute itself takes no institutional policy positions.

The Institute for the Study of Labor (IZA) in Bonn is a local and virtual international research center and a place of communication between science, politics and business. IZA is an independent nonprofit organization supported by Deutsche Post Foundation. The center is associated with the University of Bonn and offers a stimulating research environment through its international network, workshops and conferences, data service, project support, research visits and doctoral program. IZA engages in (i) original and internationally competitive research in all fields of labor economics, (ii) development of policy concepts, and (iii) dissemination of research results and concepts to the interested public.

IZA Discussion Papers often represent preliminary work and are circulated to encourage discussion.

Citation of such a paper should account for its provisional character. A revised version may be available directly from the author.

IZA Discussion Paper No. 4262 June 2009

–  –  –

We study how different payment modes influence the effectiveness of gift exchange as a contract enforcement device. In particular, we analyze how horizontal fairness concerns affect performance and efficiency in an environment characterized by contractual incompleteness. In our experiment, one principal is matched with two agents. The principal pays equal wages in one treatment and can set individual wages in the other. We find that the use of equal wages elicits substantially lower efforts. This is not caused by monetary incentives per se since under both wage schemes it is profit-maximizing for agents to exert high efforts. The treatment difference instead seems to be driven by the fact that the norm of equity is violated far more frequently in the equal wage treatment. After having suffered from violations of the equity principle, agents withdraw effort. These findings hold even after controlling for the role of intentions, as we show in a third treatment. Our results suggest that adherence to the norm of equity is a necessary prerequisite for successful establishment of gift-exchange relations.

JEL Classification: J33, D63, M52, C92, J41 Keywords: wage setting, wage equality, equity, gift exchange, reciprocity, incomplete contracts

Corresponding author:

Steffen Altmann IZA Schaumburg-Lippe-Str. 5-9 53113 Bonn Germany E-mail: altmann@iza.org * This paper is forthcoming in the Journal of the European Economic Association. Financial support from the Bonn Graduate School of Economics is gratefully acknowledged. We thank Rachel Croson, Lucie Dörner, Florian Englmaier, Ernst Fehr, Simon Gächter, Uri Gneezy, David Human, Michael Kosfeld, Peter Kuhn, Sandra Ludwig, Wolfgang Luhan, Bentley MacLeod, Clemens Puppe, Martin Sefton, Ferdinand von Siemens, Philipp Wichardt, Eyal Winter and especially Armin Falk and Felix Marklein for helpful discussions. Valuable comments were received from seminar and conference participants in Alessandria, Barcelona, Bayreuth, Bonn, Budapest, Jena, Karlsruhe, Paris, Prague, Stockholm (Ratio Colloquium), Tilburg, Vienna, and Zurich. We thank Patrick Bolton and two anonymous referees whose thoughtful comments helped to improve the paper significantly.

“To treat people fairly you have to treat people differently.” Roy Roberts, at that time VP of General Motors1

1 Introduction

In recent years, a vast body of literature has stressed the importance of gift exchange for mitigating moral-hazard problems of incomplete contracts: since many agents repay a gift in the form of higher wages by providing higher efforts, effort can be elicited under incomplete contracts even in one-shot situations where no future gains can be expected (e.g., Akerlof 1982, Fehr et al. 1997, Maximiano et al. 2007). The potential of gift exchange as a contract enforcement device, however, is likely to depend on the institutions that shape the employment relation, above all the mode of payment. Yet little is known about the interaction of different payment modes with gift exchange.

Exploring this interaction is crucial in order to understand under which conditions the efficiency-enhancing effects of gift exchange develop their full power. A key question in this context is how to treat agents relative to each other as this affects the perceived fairness of a pay scheme. In this paper, we study this question by focusing on two important fairness principles: horizontal equality and equity.





On the one hand, it has been argued that horizontal equality is crucial for a wage scheme to be considered as fair. Differential pay of co-workers could cause resentment and envy within the workforce, and ultimately lower performance (e.g., Pfeffer and Langton 1993, Bewley 1999). Wage equality is also often referred to in employerunion bargaining as being a cornerstone of a fair wage scheme and is one of the most prevalent payment modes (e.g., Medoff and Abraham 1980, Baker et al. 1988). If workers care foremost about equality, a wage scheme that guarantees equal wages for co-workers should lead to an efficiency-enhancing gift-exchange relation. On the other hand, the importance of the equity principle has long been discussed in social psychology, personnel management, and economics (e.g., Homans 1961, Konow 2003). In a work environment, the equity principle (or “equity norm”) demands that a person who exerts higher effort should receive a higher wage compared to his co-worker. Only when performance of co-workers is the same, equity and equality coincide. However, in Quoted in Baker et al. (1988).

real-life work relations this is likely to be the exception rather than the rule. Whenever workers differ in their performance, horizontal wage equality violates the equity principle since a higher effort is not rewarded with a higher wage. In other words, if equity is important, the often-heard slogan “equal pay for equal work” implies “unequal pay for unequal work”.2 Ideally, our research question would be examined in work environments that differ only with respect to the payment mode. To come close to this ideal world, we introduce a simple and parsimonious laboratory experiment that allows us to analyze the interaction between the institution of wage equality and gift exchange. In the experiment, one principal is matched with two agents. In a first stage the agents exert costly effort. After observing their efforts, the principal pays them a wage. In one treatment he can choose the level of the wage but he is obliged to pay the same wage to both agents (equal wage treatment or EWT). In our second treatment, the principal can wage discriminate between the two agents (individual wage treatment or IWT).

In both treatments, neither efforts nor wages are contractible. Note that principals in the individual wage treatment are free to pay the same wage to both agents, i.e., the EWT is a special case of the IWT. If agents care foremost about wage equality, there should thus be no treatment difference; if equity considerations are more important, we should find that the EWT elicits lower effort levels than the IWT.

The main findings of the experiment are as follows. First, performance differs substantially between the EWT and the IWT: agents who are paid equal wages exert significantly lower efforts than agents who are paid individually. Effort levels are nearly twice as high under individual wages and efforts decline over time when equal wages are paid. Second, this strong treatment effect cannot be explained by differences in monetary incentives. The actual wage choices of principals imply that providing high effort levels is profitable for agents in both treatments. From a purely monetary viewpoint agents’ behavior in both treatments should thus be similar. Third, we show Lazear (1989) neatly summarizes this discussion (p. 561): “It is common for both management and worker groups such as labor unions to express a desire for homogeneous wage treatment. The desire for similar treatment is frequently articulated as an attempt to preserve worker unity, to maintain good morale, and to create a cooperative work environment. But it is far from obvious that pay equality has these effects.” that the frequent violation of the equity principle in the equal wage treatment can explain the effort differences between the treatments. In both treatments, agents who exert a higher effort and earn a lower payoff than their co-worker strongly decrease their effort in the next period. However, the norm of equity is violated much more frequently under equal wages. Principals in the IWT seem to understand the mechanisms of equity quite well. When efforts differ they do pay different wages, rewarding the harder-working agent with a higher payoff in most cases. Agents’ reactions cause completely different dynamics in the two main treatments. Under equal wages, initially hard-working agents appear to get discouraged and reduce their effort to the level of their low-performing co-workers. By contrast, in the individual wage treatment the high performers keep exerting high efforts while the low performers change their behavior and strongly increase their effort levels.

Note that principals in the IWT can set two wages instead of one in the EWT.

This opens the possibility that agents attribute a different degree of intentionality to principals’ wage choices. It could be that this additional moment of discretion has a direct impact on the treatment difference. To rule out this potential confound, we conduct an additional control treatment where principals can again choose only one wage as in the EWT. The second wage is set exogenously such that the equity principle is always fulfilled. Effort levels in the control treatment are similar to those of the IWT and much higher compared to the EWT. This strongly suggests that the difference between our two main treatments is indeed driven by agents’ desire for wages that are in line with the equity principle.

Our results suggest a psychological rationale for using individual wages. Agents perceive equal wages for unequal performance as unfair and reduce their effort subsequently. The traditional literature on incentive provision in groups comes to a similar conclusion though for a different reason. It is usually argued that the inefficiency of equal wages stems from the fact that marginal products and wages are not aligned.

This can lead to free-riding among selfish agents (e.g., Holmstr¨m 1982, Erev et al.

o 1993). We enlarge the scope of this critical view on wage equality: interestingly, in our setup it is precisely the presence of fair-minded agents and not their absence that calls for the use of individual rewards.

An earlier literature in social psychology also studies the consequences of equity in social exchanges (Homans 1961, Adams 1963, Adams 1965, Andrews 1967). In his influential equity theory, Adams (1965) operationalizes the general equity principle in an “equity formula”, which states that the ratio of outcomes to inputs should be the same for every individual.3 If this is not the case an individual experiences distress and seeks to reestablish equity. Our study complements this literature in several ways. As Mowday (1991) notes, interpreting the existing empirical evidence can often be difficult because important aspects such as the cost of effort or the relevant reference group are ambiguous. Our economic laboratory experiment offers a high level of control over these aspects. In addition, violations of the equity norm arise from the interaction of principals and agents in our study whereas they are induced by the experimenter in most earlier experiments, e.g., by making subjects believe they are over- or underqualified for a job (e.g., Adams 1963 or Lawler 1967).

Our results also inform the literature analyzing the influence of relative income on satisfaction and performance. It has been shown that relative income affects people’s well-being (e.g., Clark and Oswald 1996, Easterlin 2001, Fließbach et al. 2007).

However, it is less clear how this influences performance, i.e., whether low relative income leads to frustration and reduced performance (as in Clark et al. forthcoming and Torgler et al. 2006) or to an increase in performance due to a “positional arms race” (Neumark and Postlewaite 1998, Layard 2005, Bowles and Park 2005). The controlled laboratory environment of our experiment allows us to reconcile these differing views.

Our results indicate that the comparison process goes beyond a one-dimensional comparison of income and also includes a comparison of effort. In particular, they suggest that receiving a lower income while exerting a higher effort leads to reduced performance as this conflicts with the equity principle. By contrast, a lower income that is generated by a lower effort leads to a (small) increase in performance.

There are only a few experimental studies that analyze the interaction of payment modes and social preferences (e.g., Bandiera et al. 2005, Fehr et al. 2007, Falk et al.

2008b). Most closely related to our paper is the work of Charness and Kuhn (2007).

Here, one principal is matched with two agents who differ in their productivity; like in our study, wages and efforts are not contractible. In contrast to our results, they The idea of proportionality dates at least back to Aristotle’s Nicomachean Ethics.



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