revised version published in: Journal of Labor Economics, 2007, 25 (4), 693-723
We study worker and firm behavior in an environment where worker effort could depend on
co-workers’ wages. Theoretically, we show that an increase in workers’ ‘concerns’ with coworkers’
wages should lead profit-maximizing firms to compress wages under quite general
conditions. However, firms should be harmed by such concerns, and such concerns can
justify paying equal wages to workers of unequal productivity only when those concerns are
asymmetric (in the sense that only underpayment matters). Our laboratory experiments
indicate that workers’ effort choices are highly sensitive to their own wages, but largely
unresponsive to co-workers’ wages. Despite this, in apparent anticipation of a negative
worker reaction, firms in our experiment were more likely to compress wages when wages
became public information. Profits were not significantly reduced by a requirement to make
wages public. Overall, our results seem to weaken the case that either wage secrecy or wage
compression is a profit-maximizing policy in practice.
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