Profitable Inequality

Abstract

What is an employer's optimal design of values for promotion among his workers? Workers compete by exerting effort, and higher effort induced by greater valuations corresponds to higher profits for the employer. Introducing inequalities in valuations makes workers' values more easily recognisable, reducing their information rent, which in turn increases effort. At the same time, inequalities lead to differences in promotion attainment, potentially reducing effort. We show that if value is redistributed within or across workers, the reduction in information rent outweighs potential losses due to inequality. Maximal dispersion and maximal discrimination emerge as features of optimal designs. We confirm our theoretical predictions in an empirical application.