Incentives and Peer Effects in the Workplace: On the Impact of Inferiority Aversion on Organizational Design

Abstract

The article is concerned with understanding the impact of social preferences on the optimal organizational design of firms. We consider a moral-hazard environment with inferiority averse workers. The integration of workers in one organizational unit yields productive complementarities but also triggers income comparisons and pay inequality. Separating workers rules out social comparison but also precludes productive synergies. Instead, the firm may impose a wage-secrecy policy to keep the latter while avoiding the former. We show that, when wages are common knowledge, productive synergies and inferiority aversion are strategic substitutes under unlimited liability while they become strategic complements when workers earn rents. As a result, firms are much more likely to integrate workers when the latter are protected by limited liability. What is more, even when firms can impose wage secrecy, they prefer not to as long as workers are not too inferiority averse. In both cases, firms exploit the incentive effect of pay inequality to raise productive efforts and profits. For the same reason, firms may deliberately establish pay inequality by opting for individual performance pay rather than group bonuses. Accordingly, popular pressures for transparency and "sunshine laws" may not be in the self-interest of employees.