When Does Inequality Mean Equity? Horizontal Wage Dispersion and Employee Mobility.

We examine the association between horizontal wage dispersion – i.e. wage dispersion within hierarchical levels in firms – and employee mobility. While prior work suggests that horizontal wage dispersion induces employee mobility, we explore key contingencies—specifically, firm size and sources of horizontal wage dispersion—that determine whether such dispersion has a positive or negative effect on mobility. We distinguish between two sources of wage dispersion: 1) predicted dispersion, that is, pay variation induced by seniority provisions, and 2) residual dispersion, that is, variation in pay not explained by seniority and which is mainly attributable to differences in the productivities of employees. Using Danish employer-employee data, we find that mobility is reduced (increased) in small (large) firms, when horizontal wage dispersion is mainly predicted, and reduced (increased) in large (small) firms, when it is mostly residual. We interpret these opposite findings through the lens of equity theory. We argue that in small firms there are less differences in productivity across employees within a given hierarchical level than is the case in large firms. We suggest that when employees exhibit similar productivity, reward systems where pay is based on seniority are perceived as fair. Conversely, when employees significantly differ in productivity, reward systems based on residual dispersion are perceived as fair. We offer empirical evidence that corroborates this interpretation and show implications for the quality of the retained employees. Overall, our findings point to the importance of adopting a contingent approach to unmask the employee retention potential of horizontal wage dispersion.