Inequality Aversion and the Distribution of Rewards in Organizations

Motivated by the potential tension between coordination, which may require discriminating among identical workers, and social comparisons, which may intuitively call for small pay differentials, we analyze the design of optimal rewards in an organization with inequality-averse workers whose tasks are complementary. Inequality aversion surprisingly results in higher monetary incentives and may also yield more inequality among agents. We also show that disadvantageous inequality aversion is of first-order importance compared to advantageous inequality aversion, a result that is consistent with existing evidence. Moreover, the distribution of rewards may be non monotonic, with the most inequality-averse agents lying at both ends of the distribution. Our analysis also sheds light on the crucial role of coordination, as most results would be reversed if the principal could costlessly select her most preferred equilibrium outcome.