Economics and restaurant gratuities: determining tip rates

American Journal of Economics and Sociology, The, April, 1997 by Orn B. Bodvarsson, William A. Gibson

I

Introduction

Gratuities are voluntary payments for services received, made after-the-fact. Why do people leave such voluntary payments in restaurants when there appears to be a clear incentive to enjoy the service and then leave without paying for it? Despite being part of everyday life, very little work to date has applied economics to the question of gratuities.

Cheung (1969), in a discussion of share contracts, states that tip payments are a preferable means of rewarding intensity and quality of service work when it is very costly for employers to enforce contracts and the quality of service is important to customers.(1) Hemenway (1977) discusses interesting questions about tipping and tipped occupations, but does not provide answers. Pencavel (1977) observes that gratuities resemble piece rates and are a form of remuneration in which performance is monitored by customers. Jacob and Page (1980) argue that final customers (as opposed to direct employers) will monitor workers when they have a comparative advantage in doing so. Sisk and Gallick (1985) hypothesize that restaurant tipping is an enforcement device used to protect customers from poor dining experiences because it allows customers to withhold payment until all of the service is received. Schotter (1981) says that practices such as tipping are efficient social institutions.(2) However, none of these works deal with tipping in depth.

Some have claimed that the explanation of tipping lies outside the realm of economics. While not primarily concerned with gratuities, Frank (1987) calls acts such as tipping "seemingly irrational" and seeks a sociobiological explanation for such behavior. Frank (1988) claims that tipping by infrequent customers occurs because the institution is based on honesty and trust. Due to psychobiological factors, the best way to present an appearance of trustworthiness is to be trustworthy in practice. That is, a dishonest person has difficulty passing as honest.(3) In order to maintain an aura of trustworthiness, useful in facilitating transactions, people are basically honest in their deeds since, according to Frank, it is easier to appear honest if you intend to be honest. People leave tips, even in restaurants they are not likely to patronize again, because it is the honest thing to do. However the explanation is insufficient, insofar as Frank's failure to mention that restaurant tipping occurs in some countries and not in others. It is considered quite insulting to tip a waiter in Scandinavian countries.

While there are many questions that can be asked about restaurant tipping behavior, we deal with two very important ones: (1) why is tipping either commonplace or rare in a given country?; and (2) for services that are tipped, is the amount of the tip predictable?

Tipping is an efficient way of pricing service when the ultimate customer has a large comparative advantage in monitoring output, and disputes over service quality are hard for an employer, such as a restaurateur, to adjudicate. Gratuities are more common in industries with high employee turn-over rates and thus frequent rewards for service are more effective in inducing continued quality service. In addition, tipping tends to occur when service is customized and cannot be resold and thus where independent third-party evaluation of service quality is unavailable. Gratuities increase the scope for income tax evasion that could lower the cost of service to customers and restaurateurs alike.(4) However, the important question remains why do patrons leave voluntary after-the-fact payments? We shall see that neo-classical economics alone is inadequate to explain gratuities, but that with augmentation, economic theory can provide a rationale for tipping. Given a case in which people do tip, such as in restaurants, economics successfully predicts the amount people tip.

This paper deals with tipping in sit down and be served restaurants.(5) Since tipping is practiced in these restaurants, we shall not pursue here the question of why only some service occupations are tipped. Fundamentally, a tip is a payment for service. Dealings between waiters and customers lead to the use of tipping and the reinforcement of the practice even when specific waiters and customers may not interact again.(6) Tipping partially separates waiters from restaurants as entities. The waiter is not simply an agent of the restaurateur, but is, to some extent, a separate entrepreneur. Customers may well tip the service though the meal itself was poor. Other customers, pleased with the food, may not tip if the service was poor.

A theoretical discussion of gratuities is presented in Section II. Tipping is the outcome of repeated customer interactions occurring indirectly through dealings with waiters. Fundamental to a theory about tipping is the hypothesis that tipping is a conscious payment for service and not merely a rigid, habitually applied role. Section III develops neoclassical predictions of the amount people will tip in a society in which tipping is the norm. In Section IV, we present evidence concerning these hypotheses based on a survey of customers at central Minnesota restaurants. Conclusions are in Section V.