The Effects of Vertical Pay Dispersion: Experimental Evidence in a Budget Setting

Abstract

Vertical pay dispersion is the difference in pay across different hierarchical levels within an organization (Milkovich and Newman 1996). While vertical pay dispersion may be useful in attracting, retaining, and motivating highly skilled employees (Lazear and Rosen 1981;Lazear 1995;Prendergast 1999), our study investigates a potential disadvantage; specifically, the negative impact of perceived unfairness of vertical pay dispersion on employees' budgeting decisions. We predict and find that high vertical pay dispersion motivates subordinates to misreport costs to a greater extent than low vertical pay dispersion. Furthermore, we predict and find that superiors, on average, exercise more lenient cost controls when vertical pay dispersion is high rather than low. Supplemental analysis indicates superiors are more lenient on average because of their aversion to inequity caused by vertical pay dispersion. Our results suggest that high vertical pay dispersion can compromise the overall corporate budgeting environment, where higher levels of misreporting by subordinates goes unchecked by superiors.Les r epercussions de la dispersion verticale des salaires :observations exp erimentales en contexte budg etaireLa dispersion verticale des salaires est l' ecart salarial entre diff erents echelons hi erarchiques au sein d'une organisation (Milkovich et Newman, 1996). Même si la dispersion verticale des salaires peutêtre utile pour attirer, fid eliser et motiver des employ es hautement comp etents (Lazear et Rosen, 1981;Lazear, 1995;Prendergast, 1999), elle risque de pr esenter un inconv enient qu' etudient les auteurs : l'incidence n egative de l'iniquit e perc ßue de la dispersion

Vertical Pay Dispersion, Peer Observability, and Misreporting in a Participative Budgeting Setting

“…Superiors only receive a fixed salary and do not share in the project profits. Consistent with Guo et al (), this design choice allows us to focus on distributional fairness that arises from different levels of fixed pay across hierarchical levels rather than the distributional fairness triggered by the split of project profit between superiors and subordinates (e.g., Rankin et al ; Douthit and Stevens ). We manipulate peer observability by either withholding from (peer observability absent) or revealing to (peer observability present) subordinates the actual project costs and cost reports of their peers.…”

“…Guo et al () examine the effect of vertical pay dispersion between subordinates and their immediate superior on subordinates' slack creation in a participative budgeting setting in which one subordinate is paired with one superior . They find that when vertical pay dispersion is high, subordinates view it to be distributionally unfair and consequently misreport cost to create more slack than when vertical pay dispersion is low.…”

“…Specifically, an individual's preference for conformance with the social norm is conditioned on his or her expectations about whether others will conform to the norm in this (or a similar) situation (i.e., their empirical expectations ), and if they believe others will expect them to conform to the norm in this (or a similar) situation (i.e., their normative expectations ) (Bicchieri ). Including the second subordinate in our setting, which is absent from Guo et al (), adds the potential for comparative behavior that brings empirical expectations to the forefront and thus influences the amount of slack subordinates create. Our triad structure enables us to examine how peer observability shapes social dynamics and budgeting decisions under different levels of vertical pay dispersion.…”

“…To the contrary, when vertical pay dispersion is low, subordinates are likely to perceive the pay structure to be distributionally fair (Cowherd and Levine ; Guo et al ). In such a situation, concerns for fairness and preferences for honesty both dictate that lower misreporting is appropriate (i.e., the normative expectation).…”

Discussion of “The Effects of Vertical Pay Dispersion: Experimental Evidence in a Budget Setting”

“…Guo, Libby, and Liu () (hereafter GLL) examine how pairs of subjects interact in a game framed as a capital budgeting problem. In each pairing, one subject is cast as the superior, the other as the subordinate.…”