Abstract :
We interpret workers’ confidence in their own skills as their morale, and investigate the
implication of worker overconfidence on the firm’s optimal wage-setting policies. In our
model, wage contracts both provide incentives and affect worker morale, by revealing private
information of the firm about worker skills. We provide conditions for the non-differentiation
wage policy to be profit-maximizing. In numerical examples, worker overconfidence is a
necessary condition for the firm to prefer no wage differentiation, so as to preserve some
workers’ morale; the non-differentiation wage policy itself breeds more worker overconfidence;
finally, wage compression is more likely when aggregate productivity is low.
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