A theory of wage setting behavior

Marco Fongoni and Alex Dickson ()

No 1505, Working Papers from University of Strathclyde Business School, Department of Economics

Abstract: Concerns for fairness, workers' morale and reciprocity influence firms' wage setting policy. In this paper we formalize a theory of wage setting behavior in a simple and tractable model that explicitly considers these behavioral aspects. A worker is assumed to have reference-dependent preferences and displays loss aversion when evaluating the fairness of a wage contract. The theory establishes a wage-effort relationship that captures the worker's reference-dependent reciprocity, which in turn influences the firm's optimal wage policy. The paper makes two key contributions: it identifies loss aversion as an explanation for a worker's asymmetric reciprocity; and it provides realistic and generalized microfoundation for downward wage rigidity. We further illustrate the implications of our theory for both wage setting and hiring behavior. Downward wage rigidity generates several implications for the outcome of the initial employment contract. The worker's reference wage, his extent of negative reciprocity and the firmsÃÆ'¢â‚¬â„¢ expectations are key drivers of the propositions derived.

Keywords: reference dependence; loss aversion; morale; reciprocity; employment contract; downward wage rigidity; wage setting behavior (search for similar items in EconPapers)
JEL-codes: C78 J30 J41 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2015-07, Revised 2016-02
New Economics Papers: this item is included in nep-cbe, nep-cta, nep-hpe, nep-hrm and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Published

Downloads: (external link)
http://www.strath.ac.uk/media/1newwebsite/departme ... sionpapers/15-05.pdf (application/pdf)

Related works:
Working Paper: A Theory of Wage Setting Behavior (2015)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:str:wpaper:1505

Access Statistics for this paper

More papers in Working Papers from University of Strathclyde Business School, Department of Economics Contact information at EDIRC.
Bibliographic data for series maintained by Kirsty Hall ().