Deferred Compensation and Gift Exchange: An Experimental Investigation into Multi-Period Labor Contracts

This paper examines the relationship between firms’ wage offers and workers’ supply of effort using a three-period experiment. In equilibrium, firms will offer deferred compensation: first period productivity is positive and wages are zero, while third period productivity is zero and wages are positive. The experiment produces strong evidence that deferred compensation increases worker effort; in about 70 percent of cases subjects supplied the optimal effort given the wage offer, and there was a strong effort response to future-period wages. We also find some evidence of gift exchange; worker players increased the effort levels in response to above equilibrium wage offers by a human, but not in response to similar offers by a computer. However, the estimated effect of gifts on worker behavior is of considerably smaller magnitude than the effect of deferred compensation. Finally, we find that firm players who are initially hesitant to defer compensation learn over time that it is beneficial to do so.