The Impact of Vertical and Horizontal Wage Dispersion on Employee Collusion and Effort in Tournaments

Abstract

We investigate the effect of vertical wage dispersion, defined as the difference in wages between superiors and subordinates, on subordinates’ behaviors in a competitive setting. We propose that higher vertical wage dispersion shifts subordinates’ pay referent from peers to superiors, thereby reducing their motivation to compete and increasing collusion against the superiors. Our experimental study tests this likelihood in a repeated tournament where the employee that exerts the highest effort wins the prize. Consistent with our predictions, we find that higher vertical wage dispersion increases subordinates’ desire to reduce the vertical pay gap and increases their trust in other subordinates. As a result, collusion increases and total effort drops. Crucially, we find that when vertical pay dispersion is high, the introduction of horizontal wage dispersion between subordinates shifts their pay referent back to their peers, creating the opposite effects on employee effort and collusion. We contribute to the growing research on pay dispersion by studying how wage differences alter employees’ pay referent for social comparison, which affects how they interact with their peers. We also extend tournament research by studying how a contextual variable outside the tournament, i.e., ex ante wage dispersion, could affect employees’ willingness to compete or to collude. An implication of our finding is that high vertical wage dispersion may make tournament incentives less effective for organizations.