When I taught at Illinois, there was an anecdote about professorial pay I found quite telling. At one time Professor A was the highest paid member of the faculty. Professor B got an offer to move laterally to a slightly higher ranked school. In the course of negotiations with the then Illinois dean, Professor B was offered a very substantial raise, but the Dean then committed the faux pas of remarking that he couldn't go higher because Professor A had to remain the highest paid professor on the faculty. Professor B left Illinois for the other school. Supposedly it was not the dollars that mattered, but the way his relative status was rubbed in his face.
The anecdote is interesting because it raises the question of whether absolute or relative pay matters with respect to job satisfaction and so on. To be sure, the right answer is probably that both matter, but my guess is that relative pay matters more.
My guess was further informed by another anecdote from my Illinois days. Faculty salaries were quasi-public. That is, they were available to the public, but to get them you had to go to the main campus library and request to see the annual report from the reference desk. A certain faculty member would annually do so, photocopy the law school pages, and circulate them to the entire faculty. He seemed very unhappy with his relatively low pay given his relatively high seniority.
There now seems to be some empirical evidence for the proposition that relative pay matters. A group of UC economists have posted to SSRN.com a paper entitled Inequality at Work: The Effect of Peer Salaries on Job Satisfaction:
Economists have long speculated that individuals care about both their absolute income and their income relative to others. We use a simple theoretical framework and a randomized manipulation of access to information on peers' wages to provide new evidence on the effects of relative pay on individual utility. A randomly chosen subset of employees of the University of California was informed about a new website listing the pay of all University employees. All employees were then surveyed about their job satisfaction and job search intentions. Our information treatment doubles the fraction of employees using the website, with the vast majority of new users accessing data on the pay of colleagues in their own department. We find an asymmetric response to the information treatment: workers with salaries below the median for their pay unit and occupation report lower pay and job satisfaction, while those earning above the median report no higher satisfaction. Likewise, below-median earners report a significant increase in the likelihood of looking for a new job, while above-median earners are unaffected. Our findings indicate that utility depends directly on relative pay comparisons, and that this relationship is non-linear.
The result is only partially consistent with my intuition. The idea that folks at the bottom of the relative pay scale are going to be unhappy is not surprising, of course. We all think we reside in Lake Wobegon, after all.
The apparent result that those above the median get no utility from being at the top end of the scale is somewhat surprising. Are the study's subjects all such good people that they get no utility from being better paid than their co-workers? This seems especially puzzling when one considers that UC faculty pay has a strong merit component, which means promotions have status symbol value. Indeed, money is pretty much the only counter academics have for measuring their success at competing for status. Being more highly paid thus means, at least to some extent, that you're more highly prized. And that ought to make one feel good. Right? (Which is why, of course, that money is the root of all evil.)
The full study is behind the NBER pay wall, so I haven't checked it out yet, but maybe the answer is that you have to be at the very top top to get utility from relative pay status.
So I wonder if Professor A was happy when B left?