At the end I want to refer again to Fehr and Gächter (2002). They have shown that framing has an effect on individual’s behavior. A bonus pay is experienced as more friendly than being threatend to pay a fine. As we face today a financial crisis, a discussion about incentive contracts has been started immediatly. It is claimed, that incentive contracts of bankers or so called “rist-takers” have been the driving force towards the crisis. The BaFin advices the financial branch to lower the share of incentive contracts among their employees. In order to cut the bonus payment a higher fixed-wage ought to be payed. Obviously bonus payments are ment to lead to higher levels of effort, but it might be a question of definition what effort means in the short and in the long run. Since fixed-wage labor contracts are characterized by weak performance incentives, one could concider incentive contracts as the best alternative, including explicit performance incentives. But this is rather a costly action. Taking the experimental findings of Fehr et al. (2002) into account one could claim that a fixed-wage contract does better on voluntary cooperation than incentive contracts, since the highest voluntary cooperation has been observed in the trust treatment. Recently several financial institutions lowered the bonus payments and therefore induced higher fixed wage-payments. I think, if a worker already receives a “high” wage in the sense of above average wage (depending on its definition), the bonus incentive might fails to lead in a higher intertemporal effort. It makes the worker act as a risk-neutral or even riskless worker. This may not lead to a profitable outcome in the long run and it might be more
profitable to pay a higher fixed wage. Additionally one can let the employee pay a fine, hidden beyond an extra wage account e.g. “held for failures”, which would result in a lower effort level (at least as the theory predicts), but in tendencies one might observe more reasonable extend of taking risks.
In the future, experimental economics may examine the impact of incentives on risk behavior. Do individuals become risk-neutral when they face different incentive contracts, although they were risk-averse before? This may be not quite easy to test in the laboratory, but serveys or field studies could provide answeres.
Experiments may help to search for a “risk-aversion boarder”, and also help to understand why there is even more selfish behavior in excess stake.
Table of Contents
1 Introduction
1.1 The Partial Gift Exchange Model
1.2 The Neoclassical Model of the Labor Market
2 Social Preferences
2.1 Sources of Social Preferences
3 A Gift-Exchange Experiment
3.1 “Does Fairness prevent Market Clearing? An Experimental Investigation” by Fehr et al. (1993)
3.2 Experimental Design
3.3 Experimental Predictions and Results
4 An amended Version of the latter Gift-Exchange Experiment
4.1 “Do incentive contracts undermine voluntary cooperation?” by Fehr et al. (2002)
4.2 Experimental Design
4.3 Experimental Predictions and Results
5 Conclusion
5.1 Literature
5.2 Positive Analysis and Personal View
Objectives and Core Topics
This paper examines why labor markets often deviate from neoclassical predictions, focusing on the role of fairness and reciprocity within the gift-exchange framework. The research investigates how wage levels influence worker effort and explores the impact of various contractual arrangements—such as incentive contracts versus fixed-wage agreements—on voluntary cooperation.
- The theoretical foundations of the partial gift-exchange model versus the neoclassical model.
- Empirical evidence from laboratory experiments regarding fairness and effort.
- The effect of incentive contracts on undermining voluntary cooperation.
- The influence of framing and reference points on economic behavior.
Excerpt from the Book
1.1 The Partial Gift Exchange Model
The partial gift-exchange model also known as the fair wage-effort hypothesis has been developed by Akerlof (1982). Akerlof (1982) explains the case of involuntary unemployment in the consequence of a wages above the market clearing level. Reciprocally individuals respond with a higher effort level and a buyer is willing to pay more than the minimum in order to receive a higher quality. Reciprocal fair behavior in fact is only one part of the explanation for market outcome above the neoclassical predictions. Since fairness is hard to define one can at least distinguish between positive and negative reciprocity as features of fair behavior. If individual 1 is willing to take costly actions into account in order to pay back at least a part of the kindness he has received from individual 2, is denoted as positive reciprocity. In contrast, negative reciprocity leads to a costly action by person 1 with the aim of reducing individual 2’s payoff. One cannot deny that fairness considerations have an impact on labor market principal-agent relationships. Akerlof (1982) considered fairness as an important factor in the interaction of firms and workers. He constructed a formal relationship that represents the perceived fair wage of an individual i at time t+1. The work rules are considered as e, unemployment benefit is represented by b and the unemployment stock by u.
Summary of Chapters
1 Introduction: Provides an overview of the labor market's uniqueness as a non-standard good market, introducing Akerlof's model and the neoclassical approach.
2 Social Preferences: Explores how fairness and reciprocity influence individual behavior and deviate from the assumption of purely selfish agents.
3 A Gift-Exchange Experiment: Analyzes the 1993 study by Fehr et al., which provided empirical evidence for the fair wage-effort hypothesis through controlled laboratory tests.
4 An amended Version of the latter Gift-Exchange Experiment: Examines the 2002 study by Fehr and Gächter on how incentive contracts can unexpectedly undermine voluntary cooperation.
5 Conclusion: Reviews existing literature on gift-exchange experiments and offers a personal positive analysis regarding contemporary financial incentives and risk behavior.
Keywords
Experimental Economics, Gift-Exchange, Labor Market, Fairness, Reciprocity, Involuntary Unemployment, Incentive Contracts, Neoclassical Model, Social Preferences, Voluntary Cooperation, Principal-Agent Relationship, Framing Effects, Inequity Aversion, Performance Incentives, Wage-Effort Relation
Frequently Asked Questions
What is the primary focus of this paper?
The paper focuses on the labor market and why it frequently operates differently than the standard neoclassical model, specifically investigating how fairness and social preferences influence worker effort and market outcomes.
What is the core research question?
The research asks how wages and different contractual structures affect worker effort and whether the assumption of a purely rational, selfish 'Homo Oeconomicus' is sufficient to explain observed behavior in the labor market.
Which scientific method is used?
The study relies on experimental economics, specifically analyzing data from laboratory-based gift-exchange experiments to test theoretical models against actual human behavior.
What are the central thematic fields?
The central fields include behavioral economics, labor economics, contract theory, and the psychology of fairness and reciprocity.
What is covered in the main section?
The main sections cover the theoretical introduction to Akerlof’s gift-exchange model, an in-depth look at Fehr et al.'s 1993 experiments, and an analysis of how incentive contracts impact voluntary cooperation based on the 2002 Fehr and Gächter study.
Which keywords characterize the work?
Key terms include Gift-Exchange, Labor Market, Fairness, Reciprocity, Incentive Contracts, and Voluntary Cooperation.
How do incentive contracts differ from fixed-price contracts?
The study finds that while incentive contracts are theoretically intended to increase efficiency for rational agents, they often perform worse than fixed-wage contracts because they crowd out or undermine voluntary cooperation.
Why is "framing" important in these experiments?
Framing is crucial because it influences the reference point of the subjects; for example, workers may perceive a fine (in incentive contracts) as less "friendly" than a bonus, which changes their reciprocal effort response.
Does the paper discuss real-world applications?
Yes, in the conclusion, the author links the laboratory findings to the financial crisis, arguing that "wrong" incentive structures for bankers contributed to excessive risk-taking.
- Quote paper
- Kathrin Tiecke (Author), 2010, Why Labor is not to put to work like Capital, Munich, GRIN Verlag, https://www.grin.com/document/162487
