Experimental Evidence on Inequity Aversion and Self-Selection between Incentive Contracts

When only group performance is observable, incentives depend on the distribution of payments between group members. This distribution differs between firms. In this paper, we analyze whether the coexistence of various group performance-based payment schemes on the labor market can be related to agents’ heterogeneity. We test by a laboratory experiment whether agents self-select between a competitive and a revenue-sharing payment scheme. The theory predicts a sorting of agents based on their preferences and an increase of the efficiency when the payment schemes are freely chosen by agents. Data confirm the predictions. Low inequity averse agents self-select into the competitive scheme and they are more likely to choose it if their risk aversion is low. The efficiency is increasing when the payment schemes are freely chosen. The results go in favor of a flexible labor market that leads to a better matching between compensation schemes and agents’ preferences. JEL classification: C92, D03, J33, M52.