Does Pay Inequality Affect Worker Effort? Experimental Evidence

We study worker behavior in an efficiency-wage environment where co-workers' wages can influence a worker's effort. Theoretically, we show that an increase in workers' responsiveness to co-workers' wages should lead profit-maximizing firms to compress wages. Our laboratory experiments, on the other hand, show that - while workers' effort choices are highly sensitive to their own wages - effort is not affected by co-workers' wages. This casts doubt on the notion that workers' concerns with equity might explain pay policies such as wage compression, or wage secrecy