A Model of reciprocal fairness: application to the labour contract

We investigate to what extent reciprocal considerations, exhibited by employers and employees, lead to stable gift exchange practices in the labour contract giving rise to non-compensating wage differentials among industries. We use the concept of 'sequential reciprocity equilibrium' developed by Dufwenberg and Kirchsteiger (1998, 2004) to incorporate players' preferences for reciprocity in their utility function. We model the labour relation through a one shot sequential gift giving game between an employer who proposes a wage given the employee's profitability level as exogenous and an employee who chooses his level of effort. We show that successful gift exchange practices may arise if both players actually care for reciprocity. Even though intentions act as a catalyst for opportunistic behaviours, the respect of the equity norm makes mutual cooperation more likely. We propose a direct evaluation of the determinants of gift exchange practices between French employers and employees, estimating the probabilities to observe productivity increases following upon the settlement of rent-sharing agreements in the firm. Whether we estimate the probability for the employer to propose a rent-sharing agreement or the probability for the employees to raise their effort, we show that there exists an endogeneity bias related to the variable chosen as a proxy to express the agents' perception of their opponent's fairness. This result supports the hypothesis that French employers' and their employees' decisions are influenced by reciprocity concerns. Our results concur with Akerlof and Yellen's fair wage effort hypothesis as an explanation of the persistence of non-compensating wage differentials.