When Equality is Unfair – Social Norms Between and Within Levels of a Hierarchy†

We analyze experimentally the role of vertical and horizontal fairness in labor relations with implicit contracts. We focus on two prominent wage schemes in firms with more than one agent: wage equality as an extreme form of wage compression and individual wage setting. We find that efforts and efficiency are significantly higher under individual wages. This is not caused by differences in monetary incentives since it is profit-maximizing for agents to exert high efforts under both wage schemes. The difference in effort provision is rather due to a violation of social norms within the firm: under equal wages, the agent exerting the higher effort receives a lower payoff as effort is costly. Reciprocal agents suffering from this norm violation get discouraged and decrease their effort. Our results suggest that individual reward and punishment opportunities are crucial for making reciprocity a powerful contract enforcement device. JEL classification: C92, J33, J41, M12, M52.