Performance Effects of Inequity Aversion in Incentive Contracting

Abstract:     
In order to provide a richer understanding of the incentive-performance relationship, this study examines the efficacy of multiple simultaneous incentive systems when the inclusion of social preferences is considered. Using a sample of over 750 medical professionals, I test how multiple performance based incentive systems function in the presence of inequity aversion, a specific social preference. The results show that when employees exhibit high levels of inequity aversion performance suffers under a pay-for-performance scheme. Additionally, I examine how incentive systems will function with the addition of subjectivity in the presence of social preferences. The results show that when high levels of inequity aversion interact with subjectivity in the incentive scheme the negative performance effects are exacerbated.

Keywords: Social preferences, inequity aversion, incentive compensation, subjectivity

JEL Classifications: J33, M12, I10

Working Paper Series