Status and incentives.

This article introduces status as reflecting an agent's claim to recognition in her work. This is a scarce resource: increasing an agent's status requires that another agent's status be decreased. Higher-status agents are more willing to exert effort in exchange for money; better-paid agents would exert higher effort in exchange for improved status. The results are consistent with actual management practices: (i) egalitarianism is desirable in a static context; (ii) in a long-term work relationship, juniors' compensation is delayed; and (iii) past performance is rewarded by pay increases along with improved status within the organization's hierarchy.

1. Introduction

Although economists have generated a substantial amount of research on work incentives, their approach remains at odds with much of the management and organization literature on the subject. The logic of using money to induce effort, which is the main focus of economic analysis, is definitely a key feature of actual incentive packages. Yet, a mere description of monetary incentive schemes falls short of providing a full account of management practices. Even in cases where direct monetary incentives are used extensively, they are associated with other types of benefits ranging from travel or goods to symbolic rewards. It is, for instance, a common practice to grant top sales people medals, rings, sculptures, plaques, and so on, handed out during lavish ceremonies (see Nelson, 1994). It is often argued that goods, although a poor substitute for money according to standard economic theory, are an effective means of providing incentives owing to their trophy value: they remind the winner and others of her/his successful past performance. Wood (1998) quotes Will Haffer, vice president of sales with Bowne Publishing, reminiscing about winning a large-screen TV: "Actually the main reason I wanted it was that it was the top prize. I could afford to buy a big screen but it was not the same as winning it."

Whereas the above examples suggest that there are some benefits in stressing differences between employees, the opposite point is often made that it is appropriate to adopt an egalitarian approach by expunging symbolic differences (see Pfeffer, 1994). A substantial body of research has emerged in the wake of Adams (1965) on the impact of "unequal" or "unfair" treatment on work motivation. According to Adams's "equity" theory, people react to inequity by making up for it. For instance, they lower their input if they feel that what they obtain in return is insufficient relative to others around them. (1) Whereas status differences are enjoyed by those with a high status, they are disliked by those with a low status who, as a result, lose motivation. Hence, recognition should not be viewed as a cheap substitute for money. It has a cost because it is valued in relative terms: what matters is earning more recognition than others. In the present article we propose a simple framework in which the desirability of using status to stress differences between organization members can be assessed.

Typically, sociologists refer to social status as capturing the need for social recognition. As defined by Weber (1922), social status is "an effective claim to social esteem in terms of negative or positive privileges." He insists that a status ranking is not directly related to wealth or income, although it can be affected by them. Thus, Veblen's theory (1899), in which status stems mostly from relative income or wealth, is somewhat restrictive. (2) An opposite argument could actually be made for reverse causality: higher status is the basis for earning higher income. There is some experimental evidence, both from psychologists (Jemmott and Gonzalez, 1989) and economists (Ball and Eckel, 1996, 1998; Ball, Eckel, Grossman, and Zame, 2001) that an exogenous and random distribution of status among individuals has a significant impact on their relative performance. (3) Belliveau, O'Reilly, and Wade (1996) study how CEO compensation is affected by the CEO's status relative to that of the compensation committee chair. They find that high-status CEOs matched with low-status compensation chairs are significantly better paid than low-status CEOs matched with high-status compensation chairs.

We consider a multi-agent moral hazard problem and allow for an agent's preferences to depend directly on her status as well as income and effort. There is not much debate among economists over the fact that individuals care about status. There is, however, some discussion over the proper modelling strategy. Letting social status be an argument of the utility function is what Postlewaite (1998) calls the "direct" approach. This can be traced back to Frank (1984) (4) and has found its most compelling support in the evolutionary argument developed by Fershtman and Weiss (1998). The proponents of an alternative "instrumental" approach, where status indirectly affects an individual's consumption level, criticize the direct approach as lacking robustness: the results are sensitive to the specification of preferences (see Postlewaite, 1998). In Section 2, we argue in favor of preferences which are characterized by a complementarity between status and income: high-status agents are willing to exert more effort in exchange for additional income, whereas better-paid agents are willing to exert more effort in exchange for improved status. As sociologists would put it, agents exhibit a taste for status congruence.

Organizations can grant recognition to their members through various formal sources of status: the wage distribution, the distribution of scarce nonmonetary resources (such as offices, furniture, computers, locker rooms, and dining facilities), conspicuous awards, or, most commonly, positions in the organization's hierarchy. Although some of these attributes clearly provide material benefits (more independence, greater influence, better work conditions), many others are symbolic and their value to employees stems mostly from the social or psychological benefits they entail (self-esteem or social recognition). Here we ignore material benefits and consider the pure status ranking that might ensue, for instance, from the ranking of positions in a formal hierarchy. The choice of status allocation in a hierarchy is constrained by the production process (i.e., the technology). Yet there are many instances of firms in the same industry resorting to different hierarchies despite possessing similar production technologies. For instance, in the auto industry, Toyota has 7 layers of management between its CEO and the employees on the factory floor, whereas Ford has 17 and GM has as many as 22 (see Milgrom and Roberts, 1992). Using a panel of 300 U.S. firms over the years 1986-1999, Rajan and Wulf (2003) find a significant trend toward a reduction in the number of management layers over the period, controlling for various variables pertaining to the firm's structure, and in particular its size. This suggests that firms are to an extent able to adjust their hierarchies, and that this ability can be used to provide work incentives. In order to underline the relationship between status and work incentives, we abstract from the technical role played by the hierarchy and leave the principal a great deal of latitude to act as a social engineer.

Leaving technology to one side, the principal still faces two categories of constraints. First, the status bestowed upon agents should be deemed legitimate in order to significantly affect their behavior. Our results show that, for incentive purposes, the principal will only choose to award different status levels to agents who have had different past performance: thus legitimacy may reasonably be rooted in these performance differences. Our focus is rather on the second constraint that arises because status is enjoyed through interpersonal comparisons. Regardless of the method used to grant social recognition, its value is perceived in relative terms. For instance, when status is derived from a person's position in a formal hierarchy, increasing one agent's status necessarily involves improving her position in the hierarchy relative to others who will mechanically suffer some loss. In other words, status in organizations is a scarce resource.

Our results show that career profiles differ greatly according to whether the employer might commit to long-term incentive schemes. In a short-term interaction with no commitment, the employer chooses to introduce limited status differentiation, which usually translates into a relatively flat hierarchy. Monetary compensation is performance based, so that wages reflect productivity differences. Indeed, in one-shot work relations, status might not be handed out as a reward for good past performance. The relevant question is then whether an employer would ex ante choose to differentiate status among a priori identical workers. The answer is no. Although agents with high status are more responsive to monetary incentives, the resulting benefits are outweighed by the reduced work motivation for those with lower status. This short-term result emphasizes the cost of status differentiation stigmatized in the human resource management literature.