Asymmetric reference-dependent reciprocity, downward wage rigidity, and the employment contract

Dickson, Alex and Fongoni, Marco (2018) Asymmetric reference-dependent reciprocity, downward wage rigidity, and the employment contract. Working paper. University of Strathclyde, Glasgow.

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    Abstract

    We develop a model of asymmetric reciprocity and optimal wage setting based on contractual incompleteness, fairness, and reference dependence and loss aversion in the evaluation of wages by workers. The model establishes a positive wage-effort relationship capturing a worker’s ‘asymmetric reference-dependent reciprocity’, in which loss aversion implies negative reciprocity is stronger than positive reciprocity. Our theory provides an explanation for the observed asymmetry and dynamics of workers’ reciprocity and establishes a micro-foundation for downward wage rigidity, the implications of which shed new light on a forward-looking firm’s optimal wage setting and hiring decisions.