Performance contests and merit pay with empathic employees

This paper studies the behavioral responses of employees who are endowed with empathic abilities to different institutional designs of incentive pay. Empathic abilities motivate altruistic behavior by sensing the other's feelings toward oneself. In performance contests, empathic individuals withhold effort, most (less) strongly when facing a non‐empathic (empathic) contestant. Effort levels of both non‐empathic and empathic individuals increase with a higher probability that the contestant is of their own type. By developing a theoretical model, our analysis contributes to understanding observed individual behavior in experiments and corresponding econometric evidence. With direct merit pay, effort choices only depend on the signaling quality of the performance measure. Individuals with stronger empathic abilities may shy away from performance contests to, instead, receive merit pay. If gender governs empathic abilities, setting incentives by performance contests cannot simultaneously ensure equal pay and equal opportunities.