Fair Wages and Employee Effort: Microeconometric Evidence

Employee motivation and work morale are considered as important sources of corporate success. Therefore, employers are interested in motivating their employees and thereby enhancing employee and firm performance. According to the fair wage-effort hypothesis (Akerlof, 1982; Akerlof and Yellen, 1990), a positive relationship between work effort and perceived wage fairness can be assumed, i.e. workers reciprocate fair wages with higher work effort. In particular, experimental evidence from the laboratory has confirmed these theoretical findings, whereas field experiments provide rather mixed results. In contrast, survey-based empirical literature on behavioral consequences of fair wages is scarce. The objective of the paper is to identify behavioral consequences of fairly paid employees. Using German individual-level survey data from the Socio-Economic Panel (SOEP), the paper examines empirically, how paying fair wages affects employee effort. The study utilizes the difference between the average actual working hours and the contractual working hours per week as a measure of employee performance. The performance variable therefore measures the extra effort a worker provides to the firm. Pay fairness is evaluated with respect to the income of a worker’s respective reference group based on personal and occupational characteristics. This approach allows analyzing pay fairness more objectively as compared to investigations based mainly on subjective fairness statements. The main empirical specification of this paper is a fixed effects model, using a rich set of socio-economic control variables. To address potential bias due to endogeneity or omitted time-varying unobservable characteristics, pay fairness is additionally instrumented with its lagged values using the two-stage least squares (2SLS) within estimator. Preliminary results of the main specification indicate that workers reciprocate fair wages with additional work effort. The empirical findings therefore support the fair wage-effort hypothesis and the experimental laboratory findings concerning wage fairness and worker performance. By relying on more objective measures of pay fairness, this paper additionally complements the literature based on subjective fairness measures. Further analysis is directed to address questions of reversed causality and to estimate additional specifications to check the robustness of the main result.

References

Akerlof, G.A., 1982. Labor contracts as partial gift exchange. The Quarterly Journal of Economics 97 (4), 543-569.

Akerlof, G.A., J.L. Yellen, 1990. The fair wage-effort hypothesis and unemployment. The Quarterly Journal of Economics 105 (2), 255-283.