‘Making a Difference’: Labor Donations in the Production of Public Goods

Despite the potential for free-riding, workers motivated by ‘making a difference’ to the mission or output of an establishment may donate labor to it. When the establishment uses performance related compensation (PRC), these labor donations closely resemble a standard private provision of public goods problem. When PRC is not used, the establishment will favor setting low wages. High wages can induce an adverse selection problem; individuals without concern for the mission or output, take the job and knowingly underperform because they will not be financially penalized. Low wages help to select a labor force driven by concern for the firm’s output. Without PRC the problem differs significantly from a standard private provision of public goods situation: there need not be free-riding, contributions are non-monotonic in valuations, and contribution incentives are significant even in large populations. Even when an establishment is able to introduce perfect PRC, it may choose not to, as its impact on output may be negligible. It thus explains why firms producing public goods, or output that tends to be socially valued, may choose both low compensation, and payment that is not related to performance.