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Wage Dispersion, Compensation Policy and the Role of Firms

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  • Bryce Stephens

Abstract

Empirical work in economics stresses the importance of unobserved firm- and person-level characteristics in the determination of wages, finding that these unobserved components account for the overwhelming majority of variation in wages. However, little is known about the mechanisms sustaining these wage di¤er- entials. This paper attempts to demystify the firm-side of the puzzle by developing a statistical model that enriches the role that firms play in wage determination, allowing firms to influence both average wages as well as the returns to observable worker characteristics. I exploit the hierarchical nature of a unique employer-employee linked dataset for the United States, estimating a multilevel statistical model of earnings that accounts for firm-specific deviations in average wages as well as the returns to components of human capital - race, gender, education, and experience - while also controlling for person-level heterogeneity in earnings. These idiosyncratic prices reflect one aspect of firm compensation policy; another, and more novel aspect, is the unstructured characterization of the covariance of these prices across firms. I estimate the model's variance parameters using Restricted (or Residual) Maximum Likelihood tech- niques. Results suggest that there is significant variation in the returns to worker characteristics across firms. First, estimates of the parameters of the covariance matrix of firm-specific returns are statistically significant. Firms that tend to pay higher average wages also tend to pay higher than average returns to worker characteristics; firms that tend to reward highly the human capital of men also highly reward the human capital of women. For instance, the correlation between the firm-specific returns to education for men and women is 0.57. Second, the firm-specific returns account for roughly 9% of the variation in wages - approximately 50% of the variation in wages explained by firm-specific intercepts alone. The inclusion of firm-specific returns ties variation in wages, otherwise attributable to firm-specific intercepts, to observable components of human capital.

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File URL: ftp://ftp2.census.gov/ces/tp/tp-2005-04.pdf
File Function: First version, 2005
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Bibliographic Info

Paper provided by Center for Economic Studies, U.S. Census Bureau in its series Longitudinal Employer-Household Dynamics Technical Papers with number 2005-04.

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Length: 47 pages
Date of creation: Nov 2005
Date of revision:
Handle: RePEc:cen:tpaper:2005-04

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Related research

Keywords: compensation policy; employer-employee longitudinal data; human capital;

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References

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  1. John M. Abowd & Bryce E. Stephens & Lars Vilhuber & Fredrik Andersson & Kevin L. McKinney & Marc Roemer & Simon Woodcock, 2009. "The LEHD Infrastructure Files and the Creation of the Quarterly Workforce Indicators," NBER Chapters, in: Producer Dynamics: New Evidence from Micro Data, pages 149-230 National Bureau of Economic Research, Inc.
  2. John M. Abowd & Francis Kramarz & David N. Margolis, 1994. "High Wage Workers and High Wage Firms," NBER Working Papers 4917, National Bureau of Economic Research, Inc.
  3. Ana Rute Cardoso, 1999. "Firms' wage policies and the rise in labor market inequality: The case of Portugal," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 53(1), pages 87-102, October.
  4. Casey Ichniowski & Kathryn Shaw, 2003. "Beyond Incentive Pay: Insiders' Estimates of the Value of Complementary Human Resource Management Practices," Journal of Economic Perspectives, American Economic Association, vol. 17(1), pages 155-180, Winter.
  5. Edward P. Lazear, 2003. "Firm-Specific Human Capital: A Skill-Weights Approach," NBER Working Papers 9679, National Bureau of Economic Research, Inc.
  6. Lazear, Edward P, 2000. "The Future of Personnel Economics," Economic Journal, Royal Economic Society, vol. 110(467), pages F611-39, November.
  7. A. R. Cardoso, 2000. "Wage differentials across firms: an application of multilevel modelling," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(4), pages 343-354.
  8. Baker, George & Gibbs, Michael & Holmstrom, Bengt, 1994. "The Wage Policy of a Firm," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 921-55, November.
  9. Steven J. DAVIS & John HALTIWANGER, 1996. "Employer Size and the Wage Structure in U.S. Manufacturing," Annales d'Economie et de Statistique, ENSAE, issue 41-42, pages 323-367.
  10. Peter Cappelli & David Neumark, 2001. "Do "high-performance" work practices improve establishment-level outcomes?," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 54(4), pages 737-775, July.
  11. Erica Groshen & David Levine, 1998. "The rise and decline(?) of U.S. internal labor markets," Research Paper 9819, Federal Reserve Bank of New York.
  12. Groshen, Erica L, 1991. "Sources of Intra-industry Wage Dispersion: How Much Do Employers Matter?," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 869-84, August.
  13. Brown, Charles & Medoff, James, 1989. "The Employer Size-Wage Effect," Journal of Political Economy, University of Chicago Press, vol. 97(5), pages 1027-59, October.
  14. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  15. Bronars, Stephen G & Famulari, Melissa, 1997. "Wage, Tenure, and Wage Growth Variation within and across Establishment," Journal of Labor Economics, University of Chicago Press, vol. 15(2), pages 285-317, April.
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