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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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find that co-workers’ wages do not matter much for agents’ decisions. However, their design differs from ours in several important points. While Charness and Kuhn focus on heterogeneity in productivity, we look at the effect of actual output differences between agents. Furthermore, we allow for richer comparisons between the agents, as in their design agents are not aware of the magnitude and direction of the productivity differences. The different results underline the importance of information for determining the reference group: Charness and Kuhn’s results rather apply to groups of workers that are loosely related and know little about each other, while our focus is on close co-workers who have a good understanding about their peers’ abilities and efforts.

Regarding compensation practice in firms, our findings highlight the importance of taking the concerns for co-workers’ wages into account. However, doing so by paying equal wages to a group of agents may actually do more harm than good.

As soon as agents differ in their performance, equal wages which seem to be a fair institution at first sight might be considered very unfair. While the discouraging effect of equal wages on hard-working agents has long been informally discussed (e.g., Milgrom and Roberts 1992, p. 418f) this paper provides controlled evidence in favor of this intuition. Moreover, it suggests that it is the violation of the norm of equity that causes the discouragement and low performance. Our results should not be interpreted as arguments against wage equality in general. They rather point to limits of equal wages.4 Wage equality is potentially a good choice in occupations where, e.g., due to technological reasons, workers’ performance differs only slightly or where performance differences are due to random influences. In addition, the transparency of co-workers’ work efforts and wages might have an influence on the optimal choice of the pay scheme.

The remainder of this paper is structured as follows. In the next section we describe the experimental design and discuss theoretical predictions. In Section 3 we present and discuss our results and Section 4 concludes.

Independent of equity-equality trade-offs, equal wages might be beneficial for the principal because they could increase peer monitoring (Knez and Simester 2001) and lower transaction costs since contracts do not have to be negotiated with every worker individually (e.g., Prendergast 1999).

2 Experimental Setup

2.1 Design and Procedures In the experiment, one principal is matched with two agents. The subjects play a two-stage game. In the first stage, agents decide simultaneously and independently how much effort they want to provide. Exerting effort is costly for the agents. Effort choices range from 1 to 10 and are associated with a convex cost function displayed in Table 1. The principal reaps the benefits of production: every unit of effort increases his payoff by 10.

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In the second stage, after observing the effort decisions of his agents, the principal decides on wages for the two agents. The wages have to be between 0 and 100. Neither efforts nor wages are contractible. The only difference between treatments is the mode of payment. In one treatment the principal can only choose one wage w that is paid to each of the agents (equal wage treatment or EWT). In the other treatment he can discriminate between the two agents by choosing wages w1 and w2 for agent 1 and 2, respectively (individual wage treatment or IWT). The EWT is thus a special case of the IWT. At the end of each period, the two agents and the principal are informed about efforts, wage(s), and the resulting payoffs for all three players. The payoff functions for the players are summarized in Table 2.

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This game is played for twelve periods. We implemented a stranger design to


from confounding reputation effects, i.e., at the beginning of each period principals and agents were rematched anonymously and randomly within a matching group. A matching group consisted of three principals and six agents. The subjects kept their roles throughout the entire experiment. After the last period, subjects answered a short post-experimental questionnaire. The experiment was conducted in a labor market framing, i.e., principals were called “employers” and agents were called “employees”.5 Our setup is related to the gift-exchange game introduced by Fehr et al. (1993) but differs in two important aspects. First, in our experiment agents move first while in Fehr et al.’s setup the principal moves first. Our move order allows the principal to base his wage decision on the actually exerted effort. More importantly, a principal in our experiment is matched with two agents instead of one. This is an essential prerequisite to analyze the interaction between gift exchange and payment modes. It allows us to study the impact of relative wages on the perceived fairness of the wage scheme and agents’ behavior.

All participants started the experiment with an initial endowment of 400 points that also served as their show-up fee. Points earned were converted at an exchange rate of 0.01 Euro/point. The experiment was conducted at the BonnEconLab at the University of Bonn in April 2005 using z-Tree (Fischbacher 2007). For each treatment, we ran four sessions with a total of 8 matching groups (144 participants). The experiment lasted approximately 70 minutes. On average subjects earned 8.30 Euro.

2.2 Behavioral Predictions

Efficiency is determined by agents’ effort choices. It is maximized if both agents exert the highest possible effort of 10. However, if all players are rational and selfish the principal will not pay anything to the agents since wage payments only reduce his monetary payoff. Anticipating this, both agents will provide the minimal effort of one in the first stage. The finite repetition of the game in randomly rematched groups does not change this prediction. This subgame perfect equilibrium is the same for both payment modes. If all players were selfish we should therefore expect no An English translation of the instructions is available from the authors upon request.

difference between treatments.

By contrast, in laboratory experiments studying labor relations with incomplete contracts, one typically observes that efforts and wages exceed the smallest possible value. Moreover, wages and efforts are positively correlated (e.g., Fehr and G¨chter a 2000). These findings illustrate the potential of reciprocal gift exchange in enforcing incomplete contracts, as postulated in Akerlof and Yellen’s fair wage-effort hypothesis (Akerlof and Yellen 1990). A fundamental prerequisite for the functioning of giftexchange relations is that workers perceive their wage as fair. The fairness of a wage payment, however, may not only be evaluated in absolute terms, but also relative to the wages of other members in a worker’s reference group.6 This is not important for the special case of bilateral gift-exchange relationships where only one agent interacts with one principal (e.g., Fehr et al. 1997). However, horizontal fairness considerations potentially play a crucial role in our setup where workers can compare to co-workers.

How do the behavioral predictions depend on which horizontal fairness principle is most important? If agents in the experiment care foremost about wage equality, the EWT—which guarantees equal wages by design—should lead to efficient gift exchange between firms and workers. Additionally, we should expect no behavioral differences between treatments since firms in the IWT can pay their workers equal wages, too.

Given that firms in the IWT recognize workers’ desire for equal treatment, they will decide to do so. Thus, the wage-effort relationship and average effort levels should not differ across treatments. If some firms nevertheless wage discriminate between workers, the IWT should lead to less efficient outcomes than the EWT.

By contrast, if workers consider equity to be more important than equality, we should expect differences in behavior between treatments. The equity principle demands that a person who exerts a higher effort than his co-worker should receive a higher wage and payoff. Our experimental treatments differ in the extent to which the equity principle can be fulfilled by principals. Under the equal wage institution, the equity norm is violated whenever agents differ in their performance. Since both Potentially many variables influence a worker’s fairness perception of his wage, e.g., the unemployment rate, unemployment benefits, the prevailing market wage, etc. (see Akerlof 1982, Akerlof and Yellen 1990). These factors are ruled out by our experimental design, allowing us to isolate the influence of co-workers’ wages on fairness perception and effort provision.

workers receive the same wage but have to bear the cost of effort provision, the worker who exerts more effort receives a lower monetary payoff. Under individual wages, principals’ behavior determines endogenously whether the equity norm is violated or not. By differentiating wages in accordance to effort differences, principals can adhere to the norm. If we assume that at least some principals do so, we expect to see less norm violations in the IWT than in the EWT.

What are the behavioral consequences of such differences in norm fulfillment?

Agents who value equitable treatment should suffer from norm violations, feel dissatisfied and subsequently try to restore equity by adjusting their behavior. Equity theory proposes several possible reactions of agents after norm violations, such as altering own or others’ efforts or payoffs, changing one’s reference group or quitting the relationship (see Adams 1965). The virtue of our experimental design is that we can clearly identify agents’ reactions, because the only variable that an agent can change after experiencing a norm violation is his work effort. An agent who faces a disadvantageous norm violation (i.e., relative underpayment) should lower his effort in the following period. An agent who experiences an advantageous norm violation (i.e., relative overpayment) should increase his effort. Note that a norm violation always includes one agent facing a disadvantageous violation and one agent facing an advantageous violation. Dissatisfaction and the resulting strength of reactions, however, is likely to depend on the direction of the norm violation. Previous evidence suggests that the decrease of effort after a disadvantageous norm violation will be stronger than the increase of effort after an advantageous violation (Loewenstein et al. 1989, Mowday 1991, Th¨ni and G¨chter 2008). Consequently, a violation of the equity norm should o a lead to an overall decrease of efforts in the subsequent period.

If workers care about equitable payment in the sense of the postulated equity norm, aggregate effort in the EWT should thus be lower compared to the IWT since we expect to observe less norm violations in the latter.

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In this section we present the results of the experiment and discuss possible explanations for the observed behavior. We first analyze efficiency implications of the two payment schemes by comparing the effort choices of agents. We then demonstrate that the difference in agents’ performance obtains even though monetary incentives— implied by principals’ wage setting—should lead to similar effort choices in both treatments. Subsequently, we show that workers’ behavior seems to be strongly affected by the equity principle, which is more frequently violated in the EWT. Finally, we report the results of an additional control experiment. They demonstrate that the higher efficiency of the IWT is not driven by the fact that principals can set two wages instead of one (as in the EWT) but by the fact that principals set wages that are in line with the equity principle.

3.1 Effort Choices and Efficiency

Figure 1 shows the development of average efforts over time. Under equal wages, efforts are lower already in the first period (Mann-Whitney test: p = 0.03)7 and decrease over time. Efforts under individual wages stay constant (Wilcoxon test for periods 1–6 against 7–12: IWT, p = 0.56; EWT, p 0.01). This results in a strong overall treatment difference: average efforts are almost twice as high in the IWT compared to the EWT (8.21 vs. 4.40; Mann-Whitney test: p 0.01). The treatment difference is also present when individual matching groups are considered: the highest average effort of an EWT matching group (5.88) is still lower than the lowest average effort of an IWT matching group (7.47).

The difference in agents’ behavior can also be seen in the histogram of effort choices (Figure 2). In the individual wage treatment agents choose the maximum effort of 10 in 49% of the cases; 84% of the choices are higher than 6. Under equal wages, agents choose an effort higher than 6 in only 26% of all cases. The effort decisions are more spread out in the EWT, the minimal effort of 1 being the modal choice with 24% of The comparison of first period effort choices is based on individual observations. Unless otherwise noted, all other tests use matching group averages as independent observations. Reported p-values are always two-sided.

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the choices. Since higher efforts increase production and since the marginal product of effort always exceeds its marginal cost, the differences in effort provision directly translate into differences in efficiency.

Result 1: The two payment modes exhibit strong differences with respect to the performance they elicit: agents who are paid equal wages exert significantly lower efforts than agents who are paid individually. This results in much higher efficiency under individual wages.

Both, the agents and the principals benefit from the increase in efficiency. The average profit per period of a principal is 56 in the EWT compared to 100 in the IWT (Mann-Whitney test: p 0.01), while an agent on average earns 10 under equal wages vs. 17 under individual wages (Mann-Whitney test: p 0.01).

3.2 Wage Setting and Monetary Incentives

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