Leading By Example: The Effect of the Leader’s Contract on Following

Leading by example is one of the most powerful methods to encourage individuals to work toward a common objective. Despite the importance of leadership, little is known about how the effectiveness of leading by example depends on the design of leaders’ compensation contracts. We conduct an experiment to examine this interplay between leadership (i.e., an informal control) and contracting (i.e., a formal control). The results show that leader effort positively influences follower effort, reflecting effective leading by example. However, this positive relation is diminished by an increase of (i) the intensity of variable compensation and / or (ii) the amount of fixed compensation in leaders’ contracts, suggesting a negative effect of contract design on the effectiveness of leading by example. Our findings inform the debate on pay transparency and show that organizations need to carefully trade-off indirect negative effects of contract design on follower effort against more direct positive effects on leaders’ own effort.