A Model of Moral Hazard with Inequity Aversion : An Experimental Test

This paper experimentally tests a moral hazard model with inequity aversion. In the model, the probability of high and low employer's revenues is determined by actions of the worker. The employer offers a revenue-dependent wage to an inequity-averse worker. In contrast to the models that assume self-centered preferences, this model explains non-negative wage offers and predicts a positive relationship between wage offers and the magnitude of the employer's revenues. A within-subject experiment is conducted with treatments corresponding to two levels of the employer's revenue. The results of the experiment are consistent with the model's predictions. In particular, an increase in the variability of the employer's revenue translates into a less stable worker compensation. Estimates of the inequity aversion and risk aversion parameters are reported