Pay transparency: fairness and morale considerations in wage-setting policies considerations in wage-setting policies

The emergence of pay transparency policies suggests an increased emphasis on fairness within the workplace. Nonetheless, the implications of pay transparency on pay structures and organizational performance remain unclear. This paper builds on the model of Fang and Moscarini (2005) to formalize employees’ responses to pay information and to subsequently determine the firm’s optimal wage policy and corresponding firm profits. In this extended model, the employees are offered a contingent wage contract and perform a simple task which they can either complete successfully or not. Only in case of success the employee is compensated. The firm’s employees are concerned with their own individual payoff in addition to believing performance should be rewarded equally. Pay transparency serves as a self-evaluation mechanism to employees and influences their perceptions of fairness. This paper suggests that balancing employees’ fairness perceptions, their confidence in their ability and the benefits of tailoring contracts determines the optimal wage policy of the firm.