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The influence of potential on wages and effort

Abstract

We investigate how employee potential influences wage offers and effort exertion in a gift exchange experiment. In particular, we test if gift exchange based on a commonly accepted norm for wage differentiation can emerge in a setting where the wage demands of agents are heterogeneous. We also analyse how communication by principals responds to the unequal wage demands and how it influences agents’ decisions about working effort in the presence of varying degrees of bargaining power. We find that differences in productivity and the resulting entitlements lead to differentiation in wages. High productivity agents are offered substantially higher wages than low productivity agents. Results from a control experiment suggest that a large part of this wage markup is related to the future productivity potential of high performers. At the same time, unequal wage schemes do not substantially crowd out effort exertion: we observe no strong detrimental effects from disadvantageous relative wage positions. Certain communication patterns significantly influence effort exertion.

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Fig. 1

Notes

  1. Using an extensive field data set from German retail banks, Kampkötter and Sliwka (2011) find that wage differentiation has a positive impact on subsequent performance. For more general theoretical analyses of how norms in the workplace influence behavior of employees and how they interact with incentives see Sliwka (2007), Ellingsen and Johannesson (2008b) and Fischer and Huddart (2008).

  2. In the context of a trilateral gift exchange game where the principal does not have the possibility to choose unequal wage profiles, Thöni and Gächter (2015) also observe peer effects with respect to effort choices.

  3. The form of the payoff function was chosen to ensure that the department head could not suffer losses in the experiment.

  4. The procedure ensured that either 27 or 30 subjects per session could interact in new department head—employee combinations for 9 rounds without being matched with previously assigned partners.

  5. The positive wage-effort relationship can be organized by theories of reciprocity (Rabin 1993; Dufwenberg and Kirchsteiger 2004; Falk and Fischbacher 2006) and inequality aversion (Fehr and Schmidt 1999; Bolton and Ockenfels 2000). There is experimental evidence that the inclusion of multiple agents in the gift exchange game does not change the fundamental behavioral patterns (see Maximiano et al. 2007). For surveys of gift exchange experiments see Gächter and Fehr (2002) and, for more recent evidence, Fehr et al. (2009) and Charness and Kuhn (2011).

  6. Communication can be a powerful means to establish cooperation in social dilemmas (see, for example Bohnet and Frey 1999; Bochet and Putterman 2009, for recent evidence and Balliet 2010, for a survey of the literature) and it increases transfers in dictator games (Rankin 2006; Mohlin and Johannesson 2008). Promises, i.e. non-binding statements of intended behavior, can positively influence beliefs about trustworthiness and subsequently the willingness to trust (Charness and Dufwenberg 2006). Brandts and Cooper (2007) investigate how communication influences behavior of employees in a company turnaround game (similar to a weakest-link game by van Huyck et al. 1990) and find that the possibility of a manager to communicate with her subordinates improves coordination to a larger extent than increasing financial incentives. Moreover, in a recent study of a turnaround game, Brandts, Cooper and Weber (forthcoming) show that leaders are able to substantially improve efficient coordination within groups by means of communication. In particular, elected leaders are more successful than random leaders, because they succeed in sending more substantive messages to agents.

  7. In one session of the BASE treatment that was conducted with 27 participants, 1 participant left during the experiment. In our analysis, we excluded the decisions of this subject and all interactions with other participants.

  8. An analogous result is found if we run the model separately for high and low performers or additionally control for the relative performance differences between the employees (models not reported here).

  9. To rule out the possibility that our results are affected by an interdependency of the variables HIGHPROD and CORRECT, we calculate models including fixed effects per experimental worker with the same dependent variables as in Model 2, separately for each of our three treatments (not reported here). From the two variables that refer to entitlements, only HIGHPROD enters the regressions as it varies over the rounds. Yet, our previous conclusions do not change. Moreover, average effort levels chosen in the experiment are uncorrelated with a subject’s performance in the quiz task so that we have no indication that the variable CORRECT affects effort through a channel other than entitlements for wages.

  10. Our results do not change if we calculate all models with the full sample.

  11. In Models 8, 9, 12 and 13, we had to exclude observations with a value of zero for OWNWAGE, as REL_WAGEDIFF is not defined in these cases.

  12. To check if previous wages serve as a reference point and have an impact of effort decisions, we calculate models similar to Models 6–9 reported in Table 6 and additionally include a variable for the employee’s wage in the last round (models not reported here). In these models we find a positive impact of the last round wage for effort of low productivity workers in a given round. Hence, it seems that besides the importance of the wage in the present round, there is also a path dependency of effort choices in the sense that low productivity agents respond more positively the higher the previous wage was. For high performers, we do not find a similar effect. All our previous conclusions remain similar.

  13. If we compare the coding of the three RAs and calculate measures for the inter-rater reliability in all message categories, we obtain values for Kappa between 0.621 and 0.853, indicating satisfactory agreement among coders.

  14. An obvious question is whether department heads use the message content strategically. Our data provides mixed evidence for such a pattern: if we calculate models with the wage paid as the dependent variable similar to the models reported in Sect. 3.1 (not reported here), we find that categories POLITENESS and EFFORT_DEMAND are positively correlated with wages while there is a negative correlation to the category EXCUSE. All other message types are not significantly related to wage choices.

  15. We conducted two experimental sessions of the RANDOM treatment in December 2014 at the LEMA (Pennsylvania State University) in which altogether 51 subjects participated. Subjects remained in the laboratory for approximately an hour; the average payoff accounted for 11.69 US-Dollars (standard deviation: 5.19 US-Dollars). Due to the fact that only 21 subjects arrived at the laboratory in the second session, a perfect strangers matching could only be implemented for 7 rounds; in the remaining rounds 8 and 9, agents were matched to principals they had previously interacted with.

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Acknowledgments

Financial support of the German Research Foundation through the Gottfried Wilhelm Leibniz Prize awarded to Axel Ockenfels and through the research unit “Design and Behavior” (FOR 1371) is gratefully acknowledged. We thank the Editor, two anonymous referees, Christian Thöni as well as conference and seminar audiences in Cologne, Göttingen, Karlsruhe, Maastricht, New York and Sydney for valuable comments and James Fan for his help in collecting the experimental data. This paper replaces a former working paper version with the title “Are Efficiency Wages Equality Wages? Exogenously Induced Fairness Norms in Working Environments”.

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Correspondence to Peter Werner.

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Bolton, G., Werner, P. The influence of potential on wages and effort. Exp Econ 19, 535–561 (2016). https://doi.org/10.1007/s10683-015-9453-0

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Keywords

  • Communication
  • Entitlements
  • Fairness norms
  • Gift exchange
  • Relative wages

JEL Classification

  • J31
  • M52
  • D63
  • C92