Social Comparisons and Peer Effects with Heterogeneous Ability ∗ Aurélie Bonein† June 25, 2015

Abstract When workers’ efforts are not perfectly contractible, the effort exerted by one worker may be influenced by his coworker’s effort. In this context, it is important that firms determine the optimal order of workers’ moves when establishing the spatial orientation of workers in the production process. A novel feature of our experiment is that we investigate whether the display of coworkers’ efforts influences wage and effort decisions and evaluate the overall impact on welfare when workers differ in ability. We find an increase in both wages and wage differences when the more able worker is observed. Observed workers increase their efforts and strength of reciprocity, and observer workers’ efforts are positively related to those of their coworkers. This strategic complementarity of efforts is partially explained by inequity aversion. On average, displaying workers’ efforts to coworkers is detrimental to employer payoff but enhances welfare, especially when the most valuable worker is observed.

Keywords: Heterogeneous ability, Gift-exchange game, Social comparison, Peer effect JEL Classification: C91, D03, J24, J31, J82

∗ I am grateful to Klaus Abbink, Catherine Eckel, Olivier l’Haridon, David Masclet, Ragan Pétrie, participants at the 1st Days of ASFEE conference in Grenoble, at the ESA meeting in Copenhagen and members of the ANR Conflict for their helpful comments and suggestions that improve the paper a lot. I would like to thank Elven Priour for his excellent help in conducting the experiments. Financial support from the French National Agency for Research (ANR Conflict ANR-08-JCJC-0105-01) is gratefully acknowledged. I gratefully acknowledge the hospitality of the University of Berkeley while working on this paper. An earlier version of this paper was circulated under the title “Wage transparency and effort comparison in the context of heterogeneous workers”. All errors remain my own. † CREM - University Rennes 1. E-mail: [email protected]

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Introduction

Although there is a long tradition in economics that emphasizes the role of financial incentives on workers’ efforts,1 the idea that these efforts are driven by more than financial incentives has received close scrutiny in recent experimental studies. These studies have shown that social pressure and peer effects (i.e., how being observed or observing others’ influences a focal worker’s behavior) might also be incentives in labor organizations (see Kandel and Lazear, 1992). In addition, social comparisons (i.e., how other workers’ outcomes influence a focal worker’s behavior) may have important implications in the labor market (see Cohn et al., 2014 for a recent discussion). Social comparisons may arise in multi-worker settings in which workers frequently interact with one another. Some firms implement practices to favor such interactions: new physical spaces (open-plan offices, places to relax, etc.), workshop sessions or the use of new information technologies (emails, chats, etc.). For instance, David Radcliffe, CEO of Hogg Robinson, notes in Management Today (January 2005) that “.... we’ve introduced e-mail free Fridays to encourage our staff to pick up the phone or walk across the office and talk to one another.”, p.6. A more recent example is Google where people in the human resources department have created the “‘perfect” environment to favor creativity and interactions among workers.2 Mackay (2007) also demonstrates that conversations within firms play a key role in workers’ efforts and in firm performance (see chapter 6). Berman et al. (2002) report the results of a survey among employers and note that, in the United States, 85% of employers approve or strongly approve workplace friendships. Such interactions may provide workers with additional information regarding coworkers’ wages and/or efforts. When workers’ effort levels cannot be enforced, this information may ultimately affect the behaviors of both upstream employers and workers, even when there are no technical externalities across production. In addition, depending on the spatial orientation of workers in the production process, workers may have the opportunity to observe how their coworkers behave (for instance, the spatial orientation of cashiers permits workers to observe coworkers placed in front of them). Because it is impossible to prevent these interactions or the dissemination of information within firms, employers must assess the impact of observing a coworker’s effort on the worker’s own effort decisions. Until now, the few studies that have examined this question have assumed that workers are identical. The purpose of this paper is to extend this research stream by examining, in the context of workers with heterogeneous abilities, whether and how the subsequent display of a worker’s effort to his coworker affects the workers’ behaviors and the employers’ upstream wage decisions. Answering this research question is of particular interest for labor organizations. Most often, workers differ from one another in terms of their abilities. This heterogeneity may result from 1 See

Gneezy et al. (2011) and Gneezy and Rey-Biel (2014) for a discussion about monetary incentives. workplace has been named in 2013 the best company to work for in America. See the original article at: http://www.cbsnews.com/news/inside-google-workplaces-from-perks-to-nap-pods/. 2 Google

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differences in length of employment, human capital, educational attainment, qualifications, skills or (more broadly) personal backgrounds. If the ability level of the observed worker (respectively observer worker) impacts the level of efficiency (i.e., the sum of efforts provided), it is important for employers to determine the optimal order of workers’ moves according to workers’ respective abilities when there is an opportunity to design the spatial orientation of workers in the production process. Although there is abundant survey and case-study evidence that has highlighted the importance of wage comparison (see Bewley, 1999, for instance) and the impact of comparing effort (see Cialdini et al., 1990, for example) on worker behavior, it is important to extend this strand of research by assessing what occurs when workers differ in ability. Under similar ability levels, employers have a priori no reason to discriminate among workers and workers may easily imitate the effort exerted by their coworkers. Workers may perceive any wage difference as unfair and such inequality may have detrimental effects on employers’ payoff and efficiency. The story is more complex when workers differ in ability. In this setting, employers may take advantage - under some conditions - to favor the most valuable workers and the question of the spillover effects in efforts remains open in this context. This is the aim of the present study where, under heterogeneous ability, we analyze whether the subsequent display of a worker’s effort to his coworker influences (i) the upstream employer’s wage decisions, (ii) the behavior of heterogeneously skilled workers and (iii) the employer’s payoff and overall welfare when there are no technical externalities across production (i.e., there is no teamwork).3 To that end, we conduct an experiment based on the gift-exchange game that was first developed by Fehr et al. (1993) to study labor relationships under contractual incompleteness in a laboratory setting.4 Each firm consists of an employer, a high-ability worker and a lowability worker. Employers and workers are equally informed about each worker’s ability, and the effort-cost relationships are common knowledge. In the first stage of the game, the employer selects the wage he offers to each worker. In the second stage, workers learn their wage and that of their coworker; then, each worker chooses his level of effort. We implement three experimental conditions that vary only with respect to the information provided to workers when they choose their effort levels. In the baseline treatment, workers were unable to observe the effort exerted by their coworker. In the second treatment, the more able worker observed the effort decision of the less able worker in his firm before selecting his own effort level. The order of workers’ decisions was reversed in the third treatment. We find that enabling effort comparisons among heterogeneously skilled workers affects wage decisions. This induces employers to increase both (i) wages and (ii) the difference between the two workers’ wages when the effort exerted by the more able worker is 3 This

paper does not discuss issues regarding the selection of workers on the basis of their ability (see Bandiera et al., 2007) or the effects on productivity of introducing high- or low-skilled workers into the setting (see, for instance, Pallais, 2014). 4 See Fehr et al., 2009 for a recent review.

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displayed. This latter wages strategy increases the targeting effect toward the most valuable worker (Bandiera et al., 2007). Regarding worker behavior, although the observed workers and the observer workers have heterogeneous levels of ability, the observability of a coworker’s effort induces observed workers, especially the less valuable ones, to increase their efforts and the strength of reciprocity (peer effect). Moreover, the efforts of observer workers are, on average, positively related to those exerted by their coworkers. This strategic complementarity of efforts is partially explained by inequity aversion. Finally, displaying a worker’s effort to his coworker has a detrimental effect on the employer’s payoff but enhances overall welfare, especially when the most valuable worker is observed. These findings have important implications for optimal workplace organization. Specifically, when an employer has the opportunity to design the spatial orientation of workers in the production process, he should favor the observability of the most valuable workers. Even if a spatial orientation with observability leads to a small decrease in the employer’s payoff relative to a setting without observability, a setting with observability generates a strong welfare-enhancing effect. Our paper is related to two strands of the literature. The first strand consists of experimental studies that address the issue of workers’ incentives under contractual incompleteness. In the moral hazard context, incentivizing workers to exert an expected effort is an important challenge for both employers and for firm performance. Akerlof (1982) and Akerlof and Yellen (1990) highlight that one of the key determinants of the effort exerted by workers is the wage received. They demonstrate a positive relationship between the wage received and the effort exerted by a worker as long as the worker’s wage falls below the “fair” wage (the fair wage-effort hypothesis). In a later study, Bewley (1999) emphasizes the importance of the fairness of a wage offer and argues that employers seem to believe that workers’ perceptions of fairness affect their productivity. The fairness of a wage offer depends not only on the level of the received wage but also on coworkers’ wages. This raises the prospect of the influence of wage comparisons among workers on (i) wage assignment, (ii) effort exerted and (iii) overall firm performance.5 Further, a horizontal dimension generated by peer effects must be considered in a multi-worker setting. It is established in the literature that individuals change their behaviors when they are observed (Hawthorne effect). Thus, the second strand of literature refers to the effects of peer pressure on productivity (Kandel and Lazear, 1992). Previous experiments in the laboratory (Falk and Ichino, 2006) and in the field (Mas and Moretti, 2009) have found that individuals enhance their efforts substantially based on concerns about how peers will view their efforts. Since these pioneering studies, some detrimental effects of peer pressure on productivity have also been noted (see Eriksson et al., 2009 for a laboratory experiment and Bellemare et al., 2010 for a field experiment, for instance). In 5 See

Charness et al. (2014) for a recent experiment and dedicated literature review.

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general, it seems that the benefits of peer effects depend on the nature of the preferences that yield such effects and the context in which peer effects apply (see Sausgruber, 2009 for a review). The present paper sheds light on the interplay between these strands of the literature because peer effects in labor organizations may be added to the vertical relationship between workers and employers and to subsequent social comparisons. Workers frequently have the opportunity to observe not only the relationships between the employer and their coworkers but also their coworkers’ behavior, and both of these observations may impact a worker’s own behavior. To that end, we use a three-person gift-exchange game. To date, only a few experiments have extended the bilateral gift-exchange game to a multi-worker setting. Among those that do, some experiments have analyzed how effort decisions are influenced by a coworker’s wage (Charness and Kuhn, 2007; Nosenzo, 2010; Gächter and Thöni, 2010; Abeler et al., 2010; Gächter et al., 2012; Cohn et al., 2014; Greiner et al., 2011), but the results of these studies are not clear-cut. For instance, Charness and Kuhn (2007) find that workers are not influenced by a coworker’s wage, whereas Nosenzo (2010) observes that knowledge of coworkers’ wages has a detrimental effect on the effort exerted by a worker. One possible explanation for this discrepancy is based on workers’ abilities. In the experiment conducted by Charness and Kuhn (2007), workers have heterogeneous abilities, whereas workers are identical in the experiment developed by Nosenzo (2010). However, this explanation must be regarded with caution because a recent study by Charness et al. (2014) shows that heterogeneous workers may also be influenced by their coworkers’ wages. More precisely, Charness et al. (2014) find that high-ability workers reduce their efforts if they are not paid more than their low-ability coworkers, but that the reverse is not true. Other studies have focused on how displaying a worker’s effort to coworkers affects workers’ efforts. Striking lessons can be drawn from these studies. Gächter et al. (2012) observe that reciprocity declines when effort is displayed. Gächter and Thöni (2014) also note that efforts are strategic complements (i.e., the effort exerted by a worker is positively related to the effort exerted by his coworker), although after the revision stage of effort decisions, conformity in effort tends toward low effort rather than high effort. Finally, Gächter et al. (2013) show that the complementarity of efforts is primarily explained by inequity aversion. However, the last three studies mentionned have two significant limitations that must be emphasized: (i) they assume that workers have identical abilities, and (ii) they do not analyze whether the observability of efforts among coworkers affects wage decisions. With the present study, we aim to contribute to this literature by considering heterogeneously skilled workers within the same firm and by examining the influence of the observability of workers’ efforts on wage and efforts decisions and its overall impact on welfare in this context. The remainder of the paper is organized as follows. The details of the experimental

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design are described in Section 2, and the results are presented in Section 3. Section 4 summarizes and concludes. Proofs can be found in the Appendix.

2

Experimental design

This section presents the gift-exchange game employed in this study. Next, it discusses the experimental conditions and the behavioral hypotheses that are derived from our setting. Finally, it describes the experimental procedure.

2.1

The three-person gift-exchange game

As is customary, we employ a labor market framework and create a small-scale laboratory replica of the interactions between employers and workers. This rich context has the advantage of facilitating participants’ understanding of the game.6 The aim of our study is to analyze whether the subsequent display of a worker’s effort to his coworker influences (i) the upstream employer’s wage decision and (ii) heterogeneously skilled workers’ behaviors. To this end, we implement a three-person gift-exchange game, which is the minimal setup to answer our research questions. The game consists of 10 periods. In each period, a three-person firm is formed by randomly and anonymously matching an employer, a high-ability worker (H-worker) and a low-ability worker (L-worker).7 Ability is fixed throughout the entire game and stems from different levels of effort exerted for a given cost. The difference in abilities means that effort is less costly for H-workers and more costly for L-workers. Modelling differences in ability in this way allows us to account for differences that arise from various sources, including educational attainment, human capital, motivations and talents. For instance, two workers may cost the same during the working day, but if one is more talented than the other or benefits from higher educational attainment, the quantity of work produced by that worker may be higher than that of a comparable worker of lesser ability.8 Thus, in our experiment, for a given cost, the H-worker’s effort is twice that of the L-worker (see Table 1). These effort-cost relationships are common knowledge. 6 Although

it remains an open question as to whether framing matters, some recent studies, such as Abbink and Hennig-Schmidt (2006), emphasize that framing does not matter. 7 To limit spurious bias during the experiment, the H-worker was called the “type A worker” and the L-worker was called the “type B worker”. 8 An alternative specification would be to use the same effort-cost relationship for both workers and to set different values for the parameter of productivity, as in Charness and Kuhn (2007) and Charness et al. (2014). But in so doing, it might be more difficult for workers to perceive the difference in ability and it is more likely to observe spillover effects in efforts.

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Table 1: Effort levels and associated costs for workers according to their ability Effort levels for H-workers Effort levels for L-workers Cost of efforts

1 0.5 0

2 1 1

3 1.5 2

4 2 4

5 2.5 6

6 3 8

7 3.5 10

8 4 12

9 4.5 15

10 5 18

Considering all of the above, the game proceeds in two stages. In the first stage, the employer - knowing the effort-cost relationship for each of his workers - determines the wage to offer to each worker. Each wage must be an integer between 0 and 100. He can offer the same wage to both workers or offer them different wages. To account for differences in ability, our payoff structures closely resemble those in Gächter et al. (2012). The employer’s payoff function is given by: π E = v · ( el + eh ) − wl − wh

(1)

where v denotes the marginal value product of effort that is set equal to 10, regardless of the worker’s ability; el and eh represent the effort levels selected by the L-worker and the H-worker, respectively. Similarly, wl and wh represent the wages offered to the L-worker and the H-worker, respectively. The employer’s payoff function is linear and strictly increasing in efforts and decreasing in wages. In the second stage, workers learn their own wage and their coworker’s wage and choose the amount of effort to supply. In addition, in some experimental treatments (see the next subsection), a worker learns the effort level exerted by his coworker before choosing his own effort level. The workers must choose an effort level from those displayed in Table 1.9,10 The effort level chosen by a H-worker will be an integer between 1 and 10, whereas the effort level chosen by a L-worker will be a multiple of 0.5 between 0.5 and 5. The payoff functions are given by: π l = wl − c ( el )

(2)

πh = wh − c(eh )

(3)

for the L-worker and

for the H-worker. c(el ) and c(eh ) denote the cost associated with the efforts exerted by the 9 The term effort is used throughout this paper, but the expression “quantity of work” was employed in the experiment, which refers to the quantity of work the worker chooses to exert to provide the employer a certain level of output. See instructions in supplementary materials. 10 Whereas stated efforts may reduce the degree of realism, they are used instead of real efforts to induce, control and manipulate differences in ability, regardless of other personal characteristics that might affect real efforts. As noted by Charness and Kuhn (2011), a clear advantage of this method is that it makes it possible to know the cost of effort and, as a result, to precisely calculate what the equilibrium effort level should be under different behavioral hypotheses.

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L-worker and by the H-worker, respectively. Regardless of ability, the worker’s payoff is strictly increasing in his own wage but decreasing in the cost of his effort. The function c(ei ) is strictly increasing and convex, with the minimum effort being costless (see Table 1). It is noteworthy that the effort produced by the worker costs him less than it benefits the employer (i.e., c(ei ) < v · ei , ∀i = {l, h}), which means that the marginal value product of effort is always higher than the marginal cost of effort, which makes maximum effort levels socially efficient. Finally, the payoff function of a worker is independent of the wage offered to his coworker and the level of effort his coworker exerts; thus, there is no earnings interdependence between workers. Overall, there are 10 periods of the game described above. At the end of each period, both the employer and workers learn their respective payoffs in the current period. Next, a new period begins in which the employers and workers are randomly reshuffled under the constraint that each player (employers and workers) is matched once with the same two opponents.11 This stranger design is common information and allows for social preferences to be isolated from reputational concerns by ruling out the possibility of future interactions. Because losses are possible for the employer (by paying high wages and receiving low effort levels from workers in response, i.e., wl + wh > v(el + eh )), all players begin the experiment with 400 points at a conversion rate of 50 points = 1.2 Euros.12 Finally, to avoid wealth effects and mitigate boredom in later periods, 4 out of 10 periods are randomly selected at the end of the experimental session for payment.

2.2 2.2.1

Experimental conditions and behavioral hypotheses Experimental conditions

The game is implemented using a between-subjects design with three experimental conditions. To answer our research questions, the experimental treatments vary along a single dimension: the observability by a worker of his coworker’s effort decision. Before describing the experimental conditions, three points should be stressed. In all treatments, the following apply: (i) the effort-cost relationship of each worker, depending on his ability, is common knowledge; (ii) wages are public information within the firm, which means that workers have full information about their coworker’s wage at the time they select their effort levels; and (iii) the first stage of the game (i.e., the employer’s wage decision) is carried out under the same conditions. We implement three experimental treatments in these conditions. In the first treatment, workers have no information about their coworker’s effort choice, i.e., effort decisions are secret (S treatment). In the second treatment, the L-worker selects his effort level first; then the H-worker observes his 11 However,

because players interacted in groups of 9 for 10 periods, in the last period, they were matched with the same players than those of period 1. 12 The methodology is similar to that adopted by Abeler et al. (2010) and Gächter and Thöni (2014).

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coworker’s effort choice and selects his effort level thereafter (L-H treatment). The order of moves is reversed in the third treatment (H-L treatment). To keep the experimental design as simple as possible, we do not allow each worker to observe how his coworker behaves, which necessarily implies a revision stage in effort decisions. 2.2.2

Behavioral hypotheses

Prior to stating our hypotheses, we must establish the sub-game perfect Nash equilibrium. Standard economic theory disregards social comparisons and fairness motives and thereby assumes that individuals are motivated exclusively by their own material interests. Because selfish workers receive a guaranteed wage that is not contingent upon their effort decisions, they put forth the minimum amount of effort, which is costless. With the foregoing in mind, the employer will offer the minimum wage, i.e., 0, to both workers. The sub-game perfect Nash equilibrium is thus {wi = 0, ∀i = {l, h} ; el = 0.5; eh = 1}. Although displaying a worker’s effort to a coworker does not affect the equilibrium under standard assumptions of selfishness, it may have an impact if we consider the influence of peer pressure and social comparison. In a first step, we consider three hypotheses in which players (both employers and workers) are not sensitive to wage differences, as previously highlighted by Charness and Kuhn (2007).13 We first argue that if employers believe that workers will respond reciprocally (i.e., that workers will exert a higher level of effort in response to being offered a higher wage), they should favor the more able worker because his effort is more valuable. Previous experiments have provided support for such behavior, which is known as the targeting effect or merit pay (Bandiera et al., 2007; Charness et al., 2014, respectively). With this in mind, our study investigates what occurs when workers can observe their coworker’s behavior. If employers believe that workers will respond reciprocally, we conjecture that employers should increase the monetary incentives to both workers (the observed worker and the observer worker) when a worker’s effort is subsequently revealed to his coworker. This wage strategy should increase both workers’ motivations by favoring the reciprocal response and limiting the detrimental effects (such as the responsibility alleviation effect, i.e., when a worker exerts low levels of effort because he has observed the high level of effort exerted by his coworker; see Owens, 2012). Further, if the employer seeks to maximize his own payoff, he should promote the most valuable worker, particularly in the H-L treatment, i.e., when the H-worker cannot be negatively influenced by his coworker’s potentially low effort level. Hypothesis 1 – Incentive effect: Higher wages should be offered when workers’ efforts are subsequently revealed to their coworkers, and the targeting effect should be more pronounced, particularly in the H-L treatment. 13 However, results from more recent papers on social comparisons in the three-person gift-exchange game

discuss this point, see the related literature at the end of Section 1.

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As noted by Mittone and Ploner (2011), the roles of the observed worker and the observer worker must be distinguished. Following the seminal study by Kandel and Lazear (1992), it might be expected that peer pressure would have some impact on the effort decision of the observed worker. By supposing that observed workers are influenced by the awareness that their effort will be revealed to their coworker (for instance, they may feel the pressure or the desire to be a good example), a framework of observable efforts should favor an increase in the average level of efforts supplied by the observed workers. If workers exert greater efforts when their efforts are observed than when their efforts are not observed regardless of the wages offered by the employer, a stronger strength of reciprocity will develop. This hypothesis is consistent with the peer pressure hypothesis of Mittone and Ploner (2011), which was established in the context of identical worker abilities. We conjecture that peer pressure may also come into play in our setting which is based on heterogeneous abilities. In line with the findings of Falk and Ichino (2006), we assume that the peer pressure effect should be stronger for L-workers because they are observed by the most valuable workers and may not want to be perceived as lowperforming workers. Conversely, H-workers are observed by workers of lesser abilities which might indicate that they feel less intense pressure. Hypothesis 2 – Peer pressure effect: Higher effort levels and strength of reciprocity should be exhibited by observed workers - and particularly the less valuable workers - compared with those found in the S treatment. The third hypothesis refers to interactions among workers’ decisions. Observing coworkers’ efforts may affect workers’ effort decisions by influencing what workers perceive to constitute appropriate behavior. Some social spillover effects may arise in terms of effort, cost of effort, and/or their relative values (i.e., ei /wi or c(ei )/wi , ∀i = {l, h}). In line with recent experimental evidence highlighted by Gächter and Thöni (2014) in the context of identical abilities, we conjecture that effort levels should be positively correlated (i.e., efforts are strategic complements) in the context of heterogeneous abilities. For instance, the effort exerted by an observed worker may be perceived as an example or an appropriate behavior that induces the observer worker to act similarly. However, we assume that the strength of these positive social spillover effects should vary based on the observer worker’s ability. When the L-worker is the observer worker, he observes the Hworker’s high effort level, which may induce the L-worker to exert a high level of effort. Conversely, when the observer worker is the H-worker, he observes the L-worker’s effort level - which may be low because the range of available efforts is smaller - and the incentive to exert a high level of effort may thus be lower for the observer H-worker. It follows that, besides the positive social spillover effects, the efforts exerted by the L-worker in the H-L treatment should be higher than those observed in the S treatment, whereas similar levels of efforts should be exerted by H-workers in the S and in the L-H treatments.

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Hypothesis 3 – Positive social spillover effect: The efforts exerted by observer workers should be positively related to those exerted by their coworkers. Until now, we have restricted social comparisons to effort comparisons. However, players may be sensitive to - or they may believe that other firm members are sensitive to - wage differences that may affect their decision. It must be stressed that wages are common knowledge in all experimental conditions. As a consequence, we do not aim to study how sensitivity regarding wage differences affects players’ decisions but instead how the observability of efforts among workers may impact players’ decisions when they express sensitivity about inequity. In the context of identical abilities, it may appear natural for employers to pay an equal wage to both workers, and any wage difference may thus produce detrimental effects on efforts; however, the scenario under heterogeneous abilities is more complex. For instance, the incentive effect (Hypothesis 1) might backfire if workers care about wage inequality and exhibit reciprocity that is not sufficiently strong to be profitable for the employer. Similarly, peer pressure and positive social spillover effects (Hypotheses 2 and 3, respectively) may be lower if workers believe that the wages offered are unfair. However, in our three-person gift-exchange game, employers and observed workers may only make some conjectures regarding the decisions of the observer workers and the resulting final payoffs. Thus, in what follows, we are particularly interested in inequity aversion as a potential explanation for the observer worker’s effort decision. This focus on inequity aversion is driven by previous experimental evidence of inequity aversion as an explanation for workers’ effort decisions (see Gächter et al., 2013).14 To this end, we refer to the model developed by Fehr and Schmidt (1999), which has the clear advantage of being tractable. This model assumes that individuals are concerned about fairness with respect to final payoff distributions, in addition to their own material payoffs. Generally speaking, individuals may exhibit aversion toward both disadvantageous inequity (they are worse off than others) and advantageous inequity (they are better off than others).15 In our three-person gift-exchange game, workers may be concerned with two dimensions of fairness: vertical fairness, which refers to the relationships between the employer and each worker, and horizontal fairness, which involves relationships among workers. Strictly speaking, if the observer workers have Fehr-Schmidt preferences, they should adjust their levels of effort up or down to minimize payoff inequities, and the strength of adjustment should be related to their individual sensitivities to payoff inequities. Hypothesis 4 – Inequity aversion: Fehr-Schmidt observer workers should choose the level of effort that minimizes payoff inequities. To examine whether inequity aversion explains the decisions observed, we conduct 14 We

do not aim to consider all social preferences models to test their respective explanatory power. For this purpose, see Gächter and Thöni (2014). 15 Presentation of the model and formal predictions are derived in Appendix 1.

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a second experiment after the three-person gift-exchange game experiment to elicit individual estimates of inequity aversion to thereby control for it. To this end, we follow the experimental design of Blanco et al. (2011).16

2.3

Procedure

Experimental sessions were conducted at the LABEX-EM, University Rennes 1. Participants were students with different educational backgrounds. The experiment was programmed and conducted using the Z-tree software (Fischbacher, 2007). Participants were invited using Orsee (Greiner, 2004). A total of 11 sessions were conducted, 3 for the S treatment and 4 for each of the two other treatments, with 18 participants per session. No subject had previously participated in a similar experiment, and nobody participated in more than one session, resulting in 198 participants. Before the experimental session started, participants were told the following: (i) there would be two independent experiments,17 (ii) the amount of money earned in the experiments would depend on their decisions and the decisions of others in their experimental group, and (iii) they would be paid the earnings they accrued in the two experiments. Participants were clearly informed that information about the earnings obtained in each experiment would be provided only at the end of the experimental session. We set this condition to reduce the potential spillover effects of earnings from one experiment to the next. Upon arrival, the subjects were randomly seated at visually separated boxes numbered from 1 to 18. For the gift-exchange game experiment, two groups of nine participants each were constructed (from box numbers 1-9 and from box numbers 10-18), with three employers, three L-workers and three H-workers per matching group. We thus took great care to ensure that the strategies and the history experienced by each participant were never contaminated and did not contaminate decision making within other matching groups. A total of two independent observations per session were guaranteed by the fact that no information passed between the two matching groups. Participants were randomly allocated to one of the two nine-person matching groups. The computer then randomly allocated the roles of the participants, who were informed of their roles at the beginning of the first period, and they retained this role throughout all 10 periods.18 Neither during nor after the experiment were subjects informed about the identity of the other participants in the room with whom they were matched. To guarantee public knowledge, instructions regarding the gift-exchange game experiment were distributed and read aloud (see supplementary materials). All participants 16 See

Appendix 2 for details. two experiments refer to the gift-exchange game experiment and the experiment dedicated to eliciting inequity aversion estimates. 18 To ensure comparability across sessions and treatments, pairings within each matching group were randomly formed prior to the first session, and these pairings were used in all the sessions. Matching grids are available from the author upon request. 17 The

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were required to answer several control questions to ensure that they understood the experimental procedures. In particular, they were required to calculate both the employers’ and workers’ payoffs in hypothetical exercises. Of course, this procedure may introduce some bias but to limit this possibility, the exercises reflected representative contingencies. Answers were privately checked and, if necessary, explained to the participants, and the experiment did not start until all participants had answered all questions correctly. Once the gift-exchange game experiment was completed, instructions for the experiment dedicated to eliciting inequity aversion estimates appeared on their screens, followed by control questions (see supplementary materials). At the end of the two experiments, the subjects learned their earnings and completed a brief post-experimental questionnaire to collect personal characteristics (i.e., gender, fields of study, etc.). Each session lasted up to 80 minutes, and the average participant earnings were 17 Euros.

3

Results

The results are presented in four steps. First, we focus on the employers’ decisions. Second, we examine the observed workers’ behaviors, and third, we examine the behaviors of the observer workers. Fourth and finally, we analyze the overall effect of displaying a worker’s effort to his coworker on employer payoff and on welfare.19 The following analysis pools all the data because no significant learning effect, especially on effort decisions, has been found.20 Finally, it is noteworthy that statistical tests are conducted at the matching group level, unless the contrary is explicitly mentioned.

3.1

Employers’ behaviors

We first analyze whether the subsequent observability of a worker’s effort by his coworker affects the upstream wage decision. To this end, Table 2 presents the mean wage of each type of worker and wage differentials by experimental treatment. Table 2: Descriptive statistics for employers’ wage offers by treatment (in experimental points)

Mean H-worker wage Mean L-worker wage Mean wages difference

S 18.07 (20.45) 14.05 (17.72) 4.02 (15.10)

Treatments L-H 22.90 (25.08) 17.89 (20.26) 5.01 (14.62)

H-L 25.97 (27.17) 18.65 (20.27) 7.32 (19.57)

Note: The table reports the mean of the variables and the standard deviation in parentheses. 19 Because

the main purpose of our experiment involves decisions made in the three-person gift-exchange game, the results regarding Experiment 2 are reported, for exposition purposes, in Appendix 2. 20 Fig. 1 and 2 in supplementary materials depict the evolution of wages and efforts over time by workers ability and experimental treatment.

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We first note that the subsequent display of a worker’s efforts to his coworker leads to an increase in both wages: H-workers receive higher wages when their effort decisions are observed than when both workers’ efforts are hidden (one-sided T-test: p = 0.0202). Similarly, H-workers receive higher wages when they observe the effort decision of their coworkers compared with the S treatment (one-sided T-test: p = 0.0379). We find the same for L-workers both when they observe their coworker (one-sided T-test: p = 0.0468) and when they are observed by their coworker (one-sided T-test: p = 0.0510). These findings suggest that the future observability of a worker’s effort by his coworker induces employers to increase, on average, their wage offers (Hypothesis 1 is satisfied). One interpretation of this behavior might be that when a worker’s effort is revealed to his coworker, the employer will provide stronger financial incentives to both workers to encourage high level of efforts.21 Figure 1: Wage decisions by treatment

In addition, allowing a worker to observe his coworker’s behavior induces the employer to modify his wage strategy. To examine this point, Fig.1 depicts wage decisions in each treatment, where the size of dots is proportional to the number of observations. The 45-degree line corresponds to equal wage decisions. For ease of examination, noncooperative wage equilibrium decisions (i.e., wh = wl = 0) are not reported. Fig. 1 suggests that when workers are able to observe their coworkers’ behaviors, the following occurs: (1) fewer employers promote L-workers (20.56% in the S treatment, 10.83% in the L-H treatment and 14.58% in the H-L treatment; Chi-square tests are significant at the 10% level), (2) more employers favor H-workers (33.33% in the S treatment, 40.42% in the L-H treatment and 37.50% in the H-L treatment; Chi-square tests are significant at 21 All

of these results are confirmed by parametric analyses reported in supplementary materials.

13

the 1% level) and (3) more employers propose an identical and non-null wage to both workers (16.11% in the S treatment, 22.50% in the L-H treatment and 24.17% in the H-L treatment; Chi-square tests are significant at the 10% level). In addition, we find that the future observation of a worker’s effort by his coworker leads to a decrease in the frequency of minimum wage decisions of employers: 30% of employers in the S treatment propose the null wage, compared with 26.25% and 23.75% in the L-H and H-L treatments, respectively; Chi-square tests are significant at the 5% level. The modifications to employers’ wage strategy and the increase in workers’ wages have an impact on wage differences. Even if both wages increase in the H-L treatment compared with the S treatment, the increase in the H-worker’s wage is stronger than that of the L-worker, which increases the difference in the two workers’ wages (see Table 2; one-sided T-test: p = 0.0434). This larger discrepancy between wages is also observed in the right panel of Fig.1 and indicates that the wage difference is even more pronounced when the H-worker’s efforts will be displayed to his coworker. However, this finding no longer holds when the L-worker acts as the leader (one-sided T-test: p = 0.2301).22 Thus, only the future observability of the H-workers’ efforts by L-workers induces employers to target their wages toward the most valuable workers (i.e., H-workers) to urge them to exert high effort levels. This result, consistent with our Hypothesis 1, might ensue because employers may believe that there will be positive social spillover effects in efforts: H-workers exerting a high level of effort may induce L-workers to provide a high level of effort thereafter and thus increase the employer’s final payoff. Another explanation refers to the order of moves: in this setting, the H-workers cannot be influenced by their coworkers’ (possibly lower) efforts. Such explanations suppose that employers believe that H-workers will respond reciprocally and that they will not be negatively affected by the wage difference. We summarize our findings for employers in Result 1. Result 1. On average, the subsequent display of a worker’s effort to his coworker induces employers to increase (i) the wages offered to both workers and (ii) the difference in wages only when the more able worker’s effort will be displayed to his coworker.

3.2 3.2.1

Workers’ behavior Observed workers

The question of interest is whether observed workers are influenced in their effort decisions by the subsequent display of their effort to their coworker who differs in ability. To examine this question, Table 3 presents some descriptive statistics. 22 Results

are confirmed by parametric analyses reported in supplementary materials.

14

Table 3: Summary statistics for workers (in experimental points)

wh wl eh el c(eh ) c ( el )

S 18.07(20.45) 14.05(17.72) 1.99(1.63) 0.93(0.87) 1.38(2.49) 1.23(2.92)

Treatments L-H 22.90(25.08) 17.89(20.26) 1.83(1.85) 1.26(1.13) 1.26(3.13) 2.30(3.92)

H-L 25.96(27.17) 18.65(20.27) 2.65(2.54) 1.22(1.15) 2.63(4.49) 2.26(4.06)

Note: The table reports the mean of the variables and the standard deviation in parentheses.

We note that, for a given ability, the workers who are observed exert greater efforts, on average, than the workers in the S treatment do. This result holds regardless of worker ability.23 This first evidence of the peer effect may be explained by the higher wage received in the context of a worker’s observable effort. To examine whether being observed induces observed workers to increase their effort level compared with the S treatment while controlling for the increase in wages between the two experimental treatments, we conduct Tobit regression analyses on effort decisions to account for the lower and upper bounds of efforts. The explanatory variables are the socio-demographic characteristics of participants, individual estimates of inequity aversion and the experimental treatments with the S treatment used as reference. We include individual fixed-effects and period fixed effects. Standard errors are clustered at the group level and account for the intragroup correlation in the error term over the 10 periods. Results are reported in Table 4. As usually observed in gift-exchange game experiments, we observe a positive and significant relationship between the wage received and the effort exerted. More interestingly here, we find that being observed induces workers to exert on average a higher level of efforts, regardless of the ability of the observed worker because the dummy variable that accounts for the experimental treatment is positive and highly significant.24 In addition, we note that workers who exhibit a strong aversion toward disadvantageous inequity (measured through α) exert, on average, a lower level of effort while those who exhibit a strong aversion toward advantageous inequity (measured through β) exert, on average, a higher level of effort. Finally, we observe that the larger is the advantageous difference in wages and the more observer workers are averse to advantageous inequity, the higher is their exerted effort (columns 2 and 4). This result holds regardless of observed 23 All

one-sided T-tests are significant at the 5% level. results are corroborated by observations made from Fig. 3. in supplementary materials. Fig. 3. presents the typical relationship between the average effort exerted and the wage received by each type of worker in each experimental condition. As is typically observed in gift-exchange laboratory experiments, we observe an upward-sloping wage-effort relationship (i.e., gift-exchange), regardless of worker ability. This basic result holds for all treatments. In addition, we observe that for any wage interval, the effort exerted by an observed worker is nearly always higher than the effort exerted by the worker of equal ability in the S treatment. This last result is especially pronounced when the observed worker is the less valuable worker. 24 These

15

worker ability. Because efforts are costly, such behaviors may be consistent with a desire to reduce the inequity in payoffs. Table 4: Estimations for the effect of the effort observability on observed workers efforts Dependent variables H-worker wage L-worker wage Experimental treatment α β α× disadva. wages difference β× adva. wages difference Constant

Socio-demographic controls Ind. fixed effects Time fixed effects Log pseudolikelihood Pseudo R-square N Left-censored observations Right-censored observations

Observed L-workers (1) (2) 0.014** 0.004 (0.007) (0.008) 0.055*** 0.066*** (0.011) (0.013) 0.571*** 0.622*** (0.092) (0.102) -0.293*** -0.294*** (0.031) (0.031) 1.914*** 1.807*** (0.219) (0.207) 0.003 (0.004) 0.043* (0.026) 0.336 0.506 (0.356) (0.370)

Observed H-workers (3) (4) 0.128*** 0.096*** (0.010) (0.023) 0.003 0.032 (0.011) (0.022) 7.801*** 7.032*** (0.573) (0.717) -1.380*** -1.335*** (0.134) (0.114) 4.501*** 2.639*** (0.351) (0.900) -0.008 (0.010) 0.083** (0.036) -2.943*** -2.288*** (0.492) (0.594)

Yes Yes Yes -261.0440 0.3774 350 217 4

Yes Yes Yes -350.423 0.3280 360 230 5

Yes Yes Yes -259.7678 0.3805 350 217 4

Yes Yes Yes -348.3350 0.3320 360 230 5

Notes: ∗∗∗ , ∗∗ , ∗ denote significance at the 1%, 5% and 10% level, respectively. Robust standard errors adjusted for clustering at the group level in parentheses. Socio-demographic controls include dummies for gender, first year student or not, economic studies or not and whether participants have a job activity. All F-test performed on socio-demographic controls are significant at the 1% level. α and β correspond to individual estimates of inequity aversion, see Appendix 1 of the manuscript.

The next step consists in analyzing whether the strength of reciprocity is also higher when the coworker’s effort is displayed compared with the S treatment. To this end, Table 5 reports the proportion of reciprocal workers and the strength of reciprocity by experimental treatment and the order of moves. Because only some workers in each matching group may be considered as reciprocal, Spearman rank correlation coefficients reported in Table 5 are computed at the individual level. Table 5 shows that the proportion of reciprocal workers is significantly higher for workers who are observed compared with the S treatment (χ2 = 42.2400, p = 0.001 for H-workers and χ2 = 86.5906, p = 0.001 for L-workers); the strength of reciprocity exhibited by observed workers is also higher compared with the S treatment. These observations are consistent with the peer pressure effect described in Hypothesis 2, which postulates that observed workers exhibit greater efforts and stronger reciprocity. A stronger strength of reciprocity can be ascribed to the awareness of being observed by their coworker. Even with no reputational considerations at work, a significant proportion of observed workers may feel pressure to set a 16

good example by exhibiting stronger reciprocity than they might exhibit if their efforts were not displayed. Table 5 also shows that the increase in the proportion of observed reciprocal workers and the increase in the strength of their reciprocity are higher for Lworkers than for H-workers when compared with the S treatment. This result is consistent with Falk and Ichino (2006) who show that low-ability workers are more sensitive to pressure from their peers than high-ability workers. The findings regarding observed workers’ behavior are summarized below. Table 5: Relationship between the wage received and the effort exerted S ρ Prob % of reciprocal workers

0.5661 < 0.001 66.66

ρ Prob % of reciprocal workers

0.6657 < 0.001 61.11

ρ Prob % of reciprocal workers

0.6456 < 0.001 72.22

Treatments L-H Overall 0.6211 < 0.001 64.58 H-workers 0.5400 < 0.001 33.33 L-workers 0.7643 < 0.001 95.83

H-L 0.6091 < 0.001 52.08 0.7440 < 0.001 66.66 0.5979 < 0.001 37.50

Notes: ρ is the Spearman correlation coefficient and Prob the associated probability. Reciprocal players are those for whom the Spearman rank correlation coefficient is significant at the 5% level.

Result 2: Despite differences in ability, being observed by their coworker induces the observed workers - particularly the less valuable ones - both to increase their effort levels and to be more reciprocal, on average. 3.2.2

Observer workers

Regarding observer workers, we investigate the following question: despite differences in workers’ abilities, is there a relationship between a worker’s effort and his coworker’s effort? To examine this question, Fig. 2 depicts this relationship for two wage ranges to account for the positive relationship between a worker’s wage and his effort level. Simple regression lines are also drawn in Fig. 2 to depict the sign of the relationship between efforts. Fig. 2 demonstrates that the observer worker’s effort is positively related to his coworker’s effort, which applies to both H-workers (left panel of Fig. 2) and Lworkers (right panel of Fig. 2). The Spearman rank correlation coefficients corroborate these observations (ρ = 0.4412, p < 0.001 in the L-H treatment and ρ = 0.3886, p < 0.001 in the H-L treatment).

17

Figure 2: Relation between workers’ effort and coworkers’ effort

To strengthen these observations, we conduct several econometric regressions. First, we perform double-censored Tobit regressions on effort decisions by controlling for the wages of both types of workers, participants’ individual sensitivity to inequity and the socio-demographic characteristics of participants. The Tobit estimates account for the efforts being left-censored by the minimum effort and right-censored by the maximum effort. Standard errors are clustered at the group level and account for the intra-group correlation in the error term over the 10 periods. The results are reported in columns (1) to (4) in Table 6. Consistent with the positive reciprocity highlighted in previous studies, the wage is a positive and strong predictor of the effort exerted for both types of workers. Moreover, the results are also clear regarding the link between efforts. We note that the observed worker’s effort has a positive impact on the effort decision made by the observer worker. This finding holds regardless of worker ability. Therefore, there are positive social spillover effects, and the efforts are strategic complements (Hypothesis 3). This finding means that despite differences in workers’ abilities, observer workers are on average influenced by the effort exerted by their coworkers. Thus, the observer worker may consider that the observed worker’s effort is “the right thing to do” or is an example to follow; accordingly, observing his coworker’s high level of effort induces the observer worker to behave the same way. Therefore, it may be important for a firm that the observed worker is a high performer.

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Table 6: Estimations for the relationship between workers efforts Dependent variables

Wage Partner’s wage Partner’s effort α β Wage × partner’s wage Partner’s wage × partner’s effort

H-worker’s effort (1) (2) 0.134*** 0.156*** (0.001) (0.002) -0.043*** -0.011*** (0.001) (0.002) 0.242*** 0.272*** (0.022) (0.037) -5.120*** -5.105*** (0.016) (0.018) 6.234*** 6.563*** (0.047) (0.062) -0.001*** (0.000) -0.000 (0.001)

L-worker’s effort (3) (4) 0.032*** 0.046** (0.012) (0.021) 0.006 0.020 (0.009) (0.014) 0.231** 0.448* (0.108) (0.268) -0.951*** -0.873*** (0.088) (0.192) 6.157*** 5.776*** (0.561) (0.852) -0.000 (0.000) -0.003 (0.004)

Partner’s relative effort Constant Socio-demographic controls Ind. fixed effects Time fixed effects Prob > F Log pseudolikelihood Pseudo or adjusted R-square N Left-censored observations Right-censored observations

-4.887*** (0.029) Yes Yes Yes 0.000 -127.288 0.4561 210 157 2

-6.293*** (0.034) Yes Yes Yes 0.000 -126.026 0.4615 210 157 2

-4.153*** (0.967) Yes Yes Yes 0.000 -186.892 0.3172 220 137 6

-4.277*** (1.453) Yes Yes Yes 0.000 -184.641 0.3254 220 137 6

H-worker’s relative effort (5)

L-worker’s relative effort (6)

0.806*** (0.147) 0.121 (0.089) Yes Yes Yes – – 0.6295 167 – –

0.488*** (0.115) 0.037* (0.019) Yes Yes Yes – – 0.4813 170 – –

Notes: Clustering errors at the group level in parentheses. Socio-demographic controls include dummies for gender, first year student or not, economic studies or not and whether participant has a job activity. All F-test performed on socio-demographic controls are significant at the 1% level. α and β correspond to individual estimates of inequity aversion, see Appendix 1. ∗∗∗ , ∗∗ , ∗ denote statistical significance at the 1%, 5% and 10% level, respectively.

Another striking result is the impact of the L-worker’s wage on the H-worker’s effort (columns (1) and (2)). The reported estimates highlight the feelings of jealousy experienced by H-workers regarding their coworkers’ wages, which tend to discourage H-workers from working at high effort levels, all else being equal. In addition, we find that the H-worker’s reaction to his own wage is contingent on his coworker’s wage; for a given H-worker’s wage, the higher his coworker’s wage is, the lower the H-worker’s effort level is (column 2). The feelings of jealousy that are associated with relatively low efforts exerted by the L-workers may explain why observer H-workers exert lower levels of effort compared with those exerted in the S treatment (see Table 3). Finally, we examine the relationship between the reciprocity exhibited by the observed worker and that of the observer worker. To approximate the degree of reciprocity, we use the relative effort, i.e., we examine the ei /wi function. We run OLS regressions on the relative effort levels. From the results reported in columns (5) and (6) in Table 6, we note, on average, a strong and positive relationship between relative efforts for both types of workers that provides additional support for the strategic complementarity of

19

efforts and the positive social spillover effect.25 By selecting his effort and the associated cost, the observer worker has the opportunity to increase or decrease the gap in final payoffs. In the following, we focus only on the equality of the workers’ final payoffs, mainly because few observations are characterized by equal final payoffs for each member of the firm. The level of his effort might be driven by inequity aversion concerns.26 To illustrate the prominence of such behavior, Fig. 3 displays the relationship between a worker’s payoff and that of his coworker in each treatment.27 The size of the dots is proportional to the number of underlying observations. For ease of observation, effort decisions associated with the null wage for both workers have been omitted. The dashed line is the 45-degree line corresponding to equal final payoffs. From Fig. 3, we note that 36.66% of workers’ choices in the L-H treatment and 36.25% in the H-L treatment aim to equalize the final payoffs, whereas the vast majority of decisions maintain the advantage of the H-worker.28 Eliciting individual inequity aversion parameters from the decisions made in Experiment 2 helps us explore the relationship between the degree of inequity aversion and the level of effort exerted in greater detail. To this end, two situations must be considered if we restrict our attention to payoffs inequity among workers.29 In the first situation, the observer worker, j, receives a lower wage than the final payoff obtained by the observed worker i, (i.e., w j < πi with πi = wi − c(ei )). In this case, the observer worker is worse off than his coworker, and the disadvantageous inequity cannot be suppressed. Therefore, the greater the workers’ aversion is to such inequity (i.e., high α), the lower the level of effort they exert to avoid widening the final payoff gap. This negative relationship is confirmed by the Spearman rank correlation coefficient: ρ = −0.5836, p = 0.0765 for L-workers.30 This finding is supported by individual estimates for sensitivity to disadvantageous inequity reported in columns (1) to (4) in Table 6, which demonstrate that, on average, the observer workers who suffer from a strong aversion toward disadvantageous inequity choose low levels of effort. 25 Robustness

checks are provided in the supplementary materials. et al. (2013) have demonstrated the influence of inequity aversion on the effort decision of the observer worker in the context of identical abilities. 27 Even if efforts are not displayed in the S treatment, the final payoffs obtained in this treatment are depicted for purposes of comparison with the other two treatments. 28 For purposes of comparison, the corresponding frequency in the S treatment is 29.44%, whereas the wage difference, i.e., before workers’ efforts, is smaller than that found in the L-H and H-L treatments. However, if we exclude effort decisions that equalize workers’ payoffs, the payoff dispersion is higher in the H-L treatment than in the S treatment. 29 If we consider the payoffs inequity among the 3 members of the firm, it results 4 conceivable cases. We present in Appendix 1 the results regarding the relationship between the degree of inequity aversion and the level of the effort exerted by the observer worker in each of these 4 cases. 30 We only have 3 effort levels for H-workers in this situation; therefore we cannot perform this test. 26 Gächter

20

Figure 3: Relation between workers’ final payoffs

In the second situation, the observer worker, j, receives a higher wage than the final payoff obtained by the observed worker i, (i.e., w j > πi with πi = wi − c(ei )). In this case, the observer worker is better off than his coworker and has the opportunity to close this gap by exerting a high and costly level of effort. In this case, the more sensitive the observer worker is to advantageous inequity (i.e., high β), the higher the level of effort. The Spearman rank correlation coefficients corroborate this strong and positive relationship for both types of workers (ρ = 0.7857, p = 0.0362 for L-workers and ρ = 0.8167, p = 0.0072 for H-workers). Further, the estimates for sensitivity to advantageous inequity reported in columns (1) to (4) in Table 6 are positive and highly significant, which indicates that the observer workers who suffer from a strong aversion toward advantageous inequity choose high effort levels. These results suggest that the degree of inequity aversion exhibited by observer workers, regardless of their ability, may explain - at least in part - their effort levels and, as a result, the strategic complementarity of efforts. Result 3: Regardless of their ability, workers exert levels of effort that are positively related to those of their coworkers, on average. This strategic complementarity of efforts is partially explained by inequity aversion.

3.3

Efficiency, employers’ payoff and welfare

The results of our experiment provide a basis to investigate whether it is beneficial for a firm to allow workers to observe their coworkers’ behaviors and whether one order of moves is better than another. To that purpose, in a final step, we analyze the impact of displaying workers’ efforts on efficiency, employers’ payoffs and welfare (in the sense of the 21

sum of final payoffs). An examination of Table 3 reveals that the effort levels are higher in the experimental treatments with observable efforts, regardless of the order of moves (one-sided T-tests: = 0.0166 for H-workers between S and H-L treatments and p < 0.001 for L-workers both between S and H-L and between S and L-H). The single exception is the observer H-workers who put forth similar levels of effort than those exerted in the S treatment (one-sided T-test: p = 0.7677) that lead them to experience lower costs than L-workers in the L-H treatment. However, in all treatments the display of worker’s effort to his coworker increases the efficiency (i.e., the sum of workers’ efforts): 13% increase in the L-H treatment and 42% increase in the H-L treatment. Nonetheless, because employers offer higher wages when workers can observe their coworkers’ behavior (Incentive effect, Hypothesis 1), these settings will benefit the employer only if the increase in efficiency is sufficiently high. Table 7: Final payoffs, efficiency and welfare (in experimental points)

πh πl πE Efficiencya Welfareb

S 16.69(19.01) 12.82(16.10) −4.79(23.88) 2.73(2.20) 24.72(19.18)

Treatments L-H 21.64(23.36) 15.59(17.96) −9.88(30.08) 3.09(2.53) 27.37(19.83)

H-L 23.33(24.10) 16.55(18.63) −5.93(29.43) 3.87(3.16) 33.82(24.89)

Note: a Efficiency corresponds to the sum of workers efforts. b Welfare corresponds to the sum of final payoffs obtained by each member of the firm. The table reports the mean of variables and the standard deviation in parentheses.

Table 7 shows that the employer’s payoff is lower in the experimental treatments in which workers’ efforts are observed by their coworkers. This means that workers do not sufficiently increase their effort levels to compensate employers for their wage offers. The decrease in employers’ payoffs is only significant in the L-H treatment (see Table 7; onesided T-test: p = 0.0247). The following explanation can be provided. From Table 3, we note that in the L-H treatment, observed L-workers increase their efforts relative to the S treatment, but observer H-workers decrease their efforts. Consequently, workers’ efforts are insufficient to compensate the cost borne by the employer as a result of the high level of wages that he is offering. It follows that allowing workers to observe their coworkers’ behavior has a detrimental effect on employers’ payoffs, primarily because employers pay higher wages that are not compensated by a sufficient increase in efficiency. Put differently, encouraging workers interactions might actually backfire the incentive effect set by the employer and be detrimental for his payoff thereafter. Conversely, workers’ final payoffs are higher, on average, in settings with observability than in the S treatment. This result holds regardless of the order of moves and the workers’ abilities (all one-sided T-tests are significant 22

at the 5% level for H-workers and at the 10% level for L-workers). Because the increase in workers’ payoffs is sufficiently high to compensate for the decrease in employers’ payoffs, displaying a worker’s effort to his coworker has welfareenhancing effects in the H-L treatment (one-sided T-test: p = 0.0033). It follows that when employers have the opportunity to design the spatial orientation of workers in the production process, they should favor an orientation that allows the most valuable workers to be observed because this orientation enhances both efficiency and welfare. Result 4: On average, showing a worker’s effort to his coworker is detrimental to the employer payoff but it enhances welfare when the most valuable worker is observed.

4

Conclusion

Despite the inescapable differences in ability among workers within a firm and the opportunity for a worker to observe his coworker’s behavior before deciding upon his own effort, we are unaware of other attempts to experimentally study how displaying a worker’s effort to his coworker affects both employers’ and workers’ decisions in this context. The results obtained in our experiment reveal that showing a worker’s effort to his coworker leads to an increase in both wages and wage differentials, particularly when the more able worker is observed. One potential explanation involves the increase in financial incentives, particularly toward the higher-valued worker when he cannot be negatively influenced by the effort exerted by his lower-valued coworker. Regarding workers’ efforts compared with situations in which the coworker’s effort is unknown, those whose behavior is observed supply a higher level of effort, on average, and a greater strength of reciprocity, which are consistent with the peer effect hypothesis. For observer workers, the level of effort they exert reflects a strategic complementarity between efforts, i.e., workers’ efforts are positively correlated with those exerted by their coworkers. One explanation of the strategic complementarity of efforts underlined here relates to inequity aversion: more than one-third of workers adjust their effort levels up or down to equalize workers’ final payoffs, whose strength is directly related to the individual parameters of inequity aversion. Overall, allowing a worker to observe his coworker’s behavior has a detrimental effect on employer payoff but positively impacts welfare, especially when the most valuable worker is observed. These findings have important implications for optimal workplace organization. When employers have the opportunity to design the spatial orientation of workers in the production process, they should favor the observability of the most valuable workers. Even if such spatial orientation leads to a small decrease in employer payoff relative to a setting characterized by unobservability, a setting that permits observability has a strong welfare-enhancing effect. Our experiment provides initial insights into how allowing the observability of ef23

forts among workers who differ in ability impacts (1) wages and efforts decisions and (ii) subsequently the efficiency of the firm. Nonetheless, two main limitations in the present study should be underlined. We have explored inequity aversion as an explanation for efforts exerted by observer workers. An alternative explanation might be related to compliance with social norms, as suggested by Gächter and Thöni (2014). If the observed worker’s effort is perceived as a norm to follow, then a higher level of effort exhibited by the observed worker will result in higher effort from the observer worker. This explanation is consistent with Mittone and Ploner (2011), who emphasize that the positive relationship between efforts may originate either from pure preferences for conformity among workers or from a combination of learning about social norms and a desire to comply with these social norms. Thus compliance with social norms may explain the positive relationship among workers’ efforts. A fruitful avenue for future research might be to investigate in more detail the role of social norms in these settings. To conduct such research, substantial changes in our experimental design will be necessary. A second limitation involves the attribution of ability. In our experiment, workers were randomly selected to be high- or low-ability workers. Being a low-ability worker may be perceived as unfair by participants, which may subsequently affect their decisions. Further, to increase the external validity of our results and thereby inform human resource policy, it would be interesting to test the robustness of our findings when ability is determined through the actual skill of participants, such as based on the results of a real-effort stage in the spirit of Charness et al. (2014).

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Appendix Appendix 1. Predictions derived from the inequity aversion model of Fehr and Schmidt (1999) in the three-person gift-exchange game case and experimental results 1. Predictions In the following, we derive the predictions of the Fehr and Schmidt (1999)’s model for the more able worker (H-worker). But it is worth pointing out that the same predictions hold for the less able worker. A Fehr Schmidt H-worker maximizes the following utility function: 1 Uh (π ) = πh − αh [max (π E − πh , 0) + max (πl − πh , 0)] 2 1 − β h [max (πh − π E , 0) + max (πh − πl , 0)] 2

(4)

with h denoting the H-worker, l the L-worker, E the employer and π represents the vector of payoffs. αh measures how much H-worker dislikes disadvantageous inequity and β h how much he dislikes advantageous inequity. Fehr and Schmidt (1999) assume αh ≥ β h so that member h suffers more from disadvantageous inequity than advantageous inequity. Second, they assume 0 ≤ β h < 1. The constraint 0 ≤ β h excludes individuals who prefer being better off than others, while β h < 1 rules out individuals who are willing to “burn” their own money to reduce advantageous inequity. Recalling that the employer’s payoff function is: π E = v ( el + eh ) − wl − wh

(5)

and those of workers:

= wl − c ( el )

(6)

πh = wh − c(eh )

(7)

πl

for the L-worker and the H-worker, respectively. The derivative of Uh (π ) with respect to the level of effort exerted eh is:31    ∂c(eh ) ∂c(eh )  − − 0.5β (− 10 − 2 )  h ∂eh    ∂eh    − ∂c(eh ) − 0.5αh (10 + 2 ∂c(eh ) ) ∂Uh ∂eh   ∂eh    = ∂c ( e ) ∂c ( e ) ∂c(eh ) h h  ∂eh − + 0.5β − 0.5α 10 +  h h ∂eh    ∂eh   ∂eh    ∂c ( e ) ∂c ( e ) h h  − − 0.5β h −10 − ∂c∂e(ehh ) ∂eh − 0.5α h ∂eh 31 The

results are symmetric if we consider the L-worker.

27

if πh > πl and πh > π E ( A) if πh < πl and πh < π E

( B)

if πh > πl and πh < π E

(C )

if πh < πl and πh > π E ( D )

(8)

The above expressions (eq. 8) are directly related to the marginal cost of the exerted effort and the sensitivity to the difference in payoffs. Thus, according to the payoff inequity and the degree of sensitivity, the H-worker is induced to increase or decrease his effort. We assume that the sensitivity to the difference in payoffs does not depend on the role of players (for example a greater sensitivity to payoffs differences with coworker than employer). The four situations are depicted in Fig. 4. To plot Fig. 4, we approximate the effort-cost functions as follows: c (eh ) = 0.1061e2h + 0.8333eh − 1.0667

(9)

c (el ) = 0.4242e2l + 1.6667el − 1.0667

(10)

with eq. (9) for the H-worker and eq. (10) for the L-worker. For exposition, we set wh = wl = 25.32 Figure 4: Location of equal payoffs in the three-person gift-exchange game

From Fig. 4, above the line π E = πh , the H-worker obtains a higher final payoff than the employer. Similarly, to the left of the line πl = πh , the H-worker obtains a higher final payoff than the L-worker. The intersection of these two lines creates four conceivable cases. • In the first case (A), the H-worker is better off than the other two players. In this case, the derivative is positive (∂Uh /∂eh > 0) if β h >

∂c(eh )/∂eh . (∂c(eh )/∂eh )+5

This means

that a H-worker with a sufficiently high β will increase his effort - that is costly 32 The

same figure holds for wh 6= wl .

28

to be closer to the employer’s payoff (an increase in effort leads to an increase in the employer’s payoff and a decrease in the H-worker’s payoff so that the payoffs difference diminishes) and to the low-ability worker’s payoff. • Regarding the symmetric situation (H-worker is worse off than the others - case of both disadvantageous inequities (B)), the derivative is unambiguously negative

(∂Uh /∂eh < 0, ∀α). Thus, the H-worker will reduce his effort to reduce the gap between his payoff and the payoffs of other members of his firm. While conclusions drawn from the first two cases (i.e., A and B) seem natural, it is more difficult without calculations to postulate the change in exerted effort when both advantageous and disadvantageous inequities are at work. • When the H-worker has the potential to earn more than his coworker but his payoff is lower than that of the employer (case C), the H-worker will unequivocally decrease his effort (∂Uh /∂eh < 0, ∀α ≥ β), assuming, as Fehr and Schmidt do, that the worker is more concerned with being behind than being ahead. • When the H-worker has an advantageous inequity with respect to the employer and a disadvantageous inequity with respect to his coworker (case D), a worker (∂c(eh )/∂eh )(2+αh ) , (∂c(eh )/∂eh )+10

∀α ≥ β) will supply the minimum effort (∂Uh /∂eh < 0). This result holds for a marginal cost of effort ranged from 0 to 10. Alternatively, a sufficiently advantageous inequity averse worker (i.e., β h > ∂(c(eh )/∂eh )(2+αh ) , ∀α ≥ β) will exert high effort (∂Uh /∂eh > 0). (∂c(e )/∂e )+10

with a low β (i.e., β h