Equality and Equity in Compensation

Abstract

Equity compensation is widely used for incentivizing skilled employees, particularly in new technology businesses. Traditional theories explaining why firms offer equity suggest that workers with higher rank should receive compensation packages more heavily weighted in equity. However, we observe the puzzle that many firms adopt an equality-in-equity strategy: they offer different cash salaries across all jobs but the same equity compensation. We propose a behavioral theory of domain-contingent inequality aversion to explain this finding: we argue that workers view salary and equity as two domains and are more inequality averse in the equity domain. Inequality in equity has a negative asymmetric effect on effort whereas the effect of inequality in salary can be positive. Our experimental findings are consistent with the existence of domain-contingent inequality aversion; we also find that inequality aversion in equity is more severe than in salary because of the perceived scarcity of equity.