Fairness and Controlling for the Uncontrollable

42 Pages Posted: 16 Aug 2016 Last revised: 20 Nov 2019

See all articles by H. Scott Asay

H. Scott Asay

University of Iowa - Department of Accounting

Jace Garrett

Clemson University

William B. Tayler

Brigham Young University

Date Written: November 18, 2019

Abstract

In practice, managers and employees often enter into risky, uncertain contracts. Prior works shows that managers use ex post discretion to reduce the effect of uncontrollable “bad luck” on employees’ performance-based compensation, but do not use ex post discretion to reduce the effect of uncontrollable “good luck,” due to fairness concerns. We investigate whether ex ante, objective compensation plans can help address the fairness concerns that lead to this asymmetric treatment of uncontrollable events. We provide evidence that compensation plans that account for uncontrollable factors can reduce differences between individuals’ fairness perceptions in good and bad luck settings. However, controlling for uncontrollable factors does not uniformly increase perceived fairness. When a favorable state of nature is realized (good luck), individuals believe, ex post, that their compensation is less fair if their agreed-upon compensation plan limits the effect of the state of nature on their compensation than if their agreed-upon compensation plan allows the state of nature to influence their compensation. In contrast, when an unfavorable state of nature is realized (bad luck), individuals believe their compensation is more fair if their agreed-upon compensation plan limits the effect of the state of nature on their compensation. We also provide evidence for two underlying psychological processes that lead to these effects and demonstrate that the effects are not simply driven by individuals viewing higher pay as being more fair.

Keywords: contract, fairness, controllability, performance, compensation

Suggested Citation

Asay, Hamilton Scott and Garrett, Jace and Tayler, William B., Fairness and Controlling for the Uncontrollable (November 18, 2019). Available at SSRN: https://ssrn.com/abstract=2823976 or http://dx.doi.org/10.2139/ssrn.2823976

Hamilton Scott Asay (Contact Author)

University of Iowa - Department of Accounting ( email )

S232 Pappajohn Business Building
Iowa City, IA 52242-1000
United States

Jace Garrett

Clemson University ( email )

Clemson, SC 29631
United States

William B. Tayler

Brigham Young University ( email )

Brigham Young University
519 TNRB
Provo, UT 84602
United States
(801) 422-5972 (Phone)
(801) 422-0621 (Fax)

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