Variable pay not only creates a link between pay and performance but may also help firms in
attracting the more productive employees (Lazear 1986, 2000). However, due to lack of
natural data, empirical analyses of the relative importance of the selection and incentive
effects of pay schemes are so far thin on the ground. In addition, these effects may be
influenced by the nature of the relationship between the firm and its employees. This paper
reports results of a laboratory experiment that analyzes the influence of other-regarding
preferences on sorting and incentives. Experimental evidence shows that (i) the opportunity
to switch to piece-rate increases the average level of output and its variance; (ii) there is a
concentration of high skill workers in performance pay firms; (iii) however, in repeated
interactions, efficiency wages coupled with reciprocity and inequality aversion reduce the
attraction of performance related pay. Other-regarding preferences influence both the
provision of incentives and their sorting effect.