Impact of an equal pay norm on the optimal design of incentive contracts

Abstract

Many firms do consider an equal pay norm when designing incentive contracts for their employees. This will affect the insights achieved in literature on incentive provision for multiple agents in a firm. We find that the consideration of an equal pay norm leads to less high-powered incentives and provides a rationale for the application of team-based compensation (TBC). When performance measures are positively correlated TBC can still be preferred over otherwise optimal relative performance evaluation schemes. What is more, the consideration of an equal pay norm makes mutual monitoring and coordination between agents more desirable than individual agent behavior. Finally, an increasing firm size decreases the desirability of individual agent behavior and correspondingly makes TBC even more attractive.