Classical and Belief-Based Gift Exchange Models: Theory and Evidence

We derive and test the predictions of three competing models of gift exchange: Classical (CGE); Augmented (AGE) based on unexpected wage surprises; and Belief-based (BGE) that uses belief hierarchies to formally model reciprocity and guilt-aversion. Following Akerlof (1982), we also introduce signals of the typical wage, θw, and effort level, θe, in similar firms. We examine the worker’s optimal effort in response to exogenous variation in the wage, w, the signals θw, θe, and a signal of the firm’s expectations of effort from the worker, s. All three models predict gift exchange, however, the predictions of the AGE and the CGE models with respect to θw, θe, and s, are rejected. The BGE model successfully explains the data in all these respects. Gift exchange is underpinned by guilt-aversion. We also provide novel empirical evidence of first order stochastic dominance of first and second order beliefs.