Equality and Equity in Compensation

Jiayi Bao and Andy Wu

Harvard Business School

2017

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.