Wage Inequality and Performance in Nonprofit and For‐Profit Organizations

• DOI: http://doi.org/10.1002/nml.21085
• Date: 01 December 2013
• Published date: 01 December 2013

Wage Inequality and

Performance in Nonprofit and

For-Profit Organizations

Darla J. Hamann,

1

Ting Ren

2

1University of Texas at Arlington, 2Peking University

This article examines the effects of several forms of wage in-

equality on service quality and employee effort. We suggest that

two popular theories, tournament and fair wage/equity, are not

necessarily competing. Each theory accurately describes

aspects of employee behavior, but because of sectoral differences

in organizational objectives and employee attitudes, tourna-

ment theory’s predictions are relatively stronger in the for-profit

sector, while fair wage/equity theory’s predictions are relatively

stronger in the nonprofit sector. Using an employer–employee

matched data set of nursing homes linked to a federal regulatory

database and a resident survey, we found that ownership moder-

ates the relationship between wage inequality and service qual-

ity. Although wage inequality positively affects service quality

in the for-profit sector, the reverse is true among nonprofit

organizations. We also found that overall wage inequality in

the workplace has a more pronounced influence on employee

discretionary effort than does the employee’s place in the distri-

bution of wages.

Keywords: wage inequality, organizational performance,

nonprofit organizations, for-profit organizations, tournament

theory, fair-wage theory

Correspondence to: Darla J. Hamann, University of Texas at Arlington, School of

Urban and Public Affairs, 601 S. Nedderman Dr., Arlington, TX 76019. E-mail:

dhamann@uta.edu

Note: We are grateful for support from Avner Ben-Ner, and from his Aspen Institute

Grant NSRF 2005–1, “A Comparative Study of Organizational Structure, Behavior

and Performance in For-Profit Firms, Government Organizations, and Nonprofit

Organizations.”

NONPROFIT MANAGEMENT & LEADERSHIP, vol. 24, no. 2, Winter 2013 © 2013 Wiley Periodicals, Inc 207

Published online in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/nml.21085

208 HAMANN, REN

Nonprofit Management & Leadership DOI: 10.1002/nml

DOES WITHIN-FIRM WAGE INEQUALITY affect performance? The

theoretical arguments for the relationship between within-

firm wage inequality and performance, drawn primarily

from tournament and fair-wage theories, have been conflicting, as

have been the empirical studies. Whether wage inequality is posi-

tively or negatively associated with performance depends on how

inequality affects employee motivation and discretionary effort,

which may depend on ownership sector (Leete 2000). Although we

suggest that there may be several factors influencing the effect of

wage inequality on organizational performance, we focused primar-

ily on comparing the predictions of tournament and fair-wage theo-

ries and discuss these theories as each explains employee behavior

in part. We suggest that because employees in the nonprofit sector

differ from their counterparts in the for-profit sector along several

dimensions (for example, intrinsic motivation, mission commit-

ment, public service motivation, and so on), the predications from

fair-wage theory are more likely to dominate the predictions

from tournament theory in this sector. We tested our hypotheses

using data from the nursing home industry in a midwestern state in

the United States, where for-profit, nonprofit, and local government

organizations operate side by side. In addition, we were able to di-

rectly test the relationship between wage inequality and employee

discretionary effort, which has been tested indirectly in the past.

Our contributions to this literature include (1) our exploration

of the factors that affect the direction of the relationship between

wage inequality and firm performance, most notably ownership,

(2) our consideration of both vertical and horizontal measures of

wage inequality, including a measure that controls occupation, and

(3) our examination of how one’s place in the wage distribution is

associated with choice of effort.

Theoretical Background of the Wage Inequality–

Performance Relationship

There are two competing theories that have implications for the

organizational performance consequences of wage inequality. The

first is tournament theory, advanced by Lazear and Rosen (1981),

which is a theory of internal labor markets in which individuals

compete for prizes, usually promotions or pay increases. In this

theory, an increased wage spread between employees at different

levels of the hierarchy, or between the highest- and lowest-paid

employees at the same level of hierarchy, will motivate workers to

provide extra effort in the hope of obtaining the raise or promo-

tion. This theory suggests that wage inequality will be positively

related to individual and organizational performance.

The second theory, based on the work in equity theory (Adams

1963, 1965) in psychology, social exchange theory (Blau 1955) in

Whether wage

inequality is

positively or

negatively

associated with

performance

depends on how

inequality affects

employee

motivation and

discretionary

effort, which may

depend on

ownership sector.