We study how employees learn about the salaries of their peers and managers, and how those beliefs affect their behavior. We conducted a field experiment with a sample of 2,000 employees from a multi-billion-dollar corporation. First, we document large
misperceptions about salaries and identify some of the sources of these misperceptions. Second, we identify the causal effects of these beliefs by means of an experiment that provided employees with feedback about the salaries of others. We combine unique
survey and administrative data to estimate cross-salary elasticities. We find that individuals do not tolerate horizontal inequality: higher perceived peer salary has large negative effects on satisfaction, effort, output and retention. On the contrary, individuals
tolerate vertical inequality: if anything, higher perceived manager salary has a positive effects on motivation, even when the likelihood of reaching the managerial position is small. Our findings reject the widespread belief that fairness concerns compress
pay inequality in the firm. We discuss other implications of these findings, including optimal transparency.