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Earnings Inequality and Coordination Costs: Evidence From U.S. Law Firms

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  • Luis Garicano
  • Thomas Hubbard

Abstract

Earnings inequality has increased substantially since the 1970s. Using evidence from confidential Census data on U.S. law offices on lawyers' organization and earnings, we study the extent to which the mechanism suggested by Lucas (1978) and Rosen (1982), a scale of operations effect linking spans of control and earnings inequality, is responsible increases in inequality. We first show that earnings inequality among lawyers increased substantially between 1977 and 1992, and that the distribution of partner-associate ratios across offices changed in ways consistent with the hypothesis that coordination costs fell during this period. We then propose a "hierarchical production function" in which output is the product of skill and time and estimate its parameters, applying insights from the equilibrium assignment literature. We find that coordination costs fell broadly and steadily during this period, so that hiring one's first associate leveraged a partner's skill by about 30% more in 1992 than 1977. We find also that changes in lawyers' hierarchical organization account for about 2/3 of the increase in earnings inequality among lawyers in the upper tail, but a much smaller share of the increase in inequality between lawyers in the upper tail and other lawyers. These findings indicate that new organizational efficiencies potentially explain increases in inequality, especially among individuals toward the top of the earnings distribution.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14741.

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Date of creation: Feb 2009
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Handle: RePEc:nbr:nberwo:14741

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  1. Steven N. Kaplan & Joshua Rauh, 2007. "Wall Street and Main Street: What Contributes to the Rise in the Highest Incomes?," NBER Working Papers 13270, National Bureau of Economic Research, Inc.
  2. Raghuram G. Rajan & Julie Wulf, 2006. "The Flattening Firm: Evidence from Panel Data on the Changing Nature of Corporate Hierarchies," The Review of Economics and Statistics, MIT Press, vol. 88(4), pages 759-773, November.
  3. Xavier Gabaix & Augustin Landier, 2006. "Why Has CEO Pay Increased So Much?," NBER Working Papers 12365, National Bureau of Economic Research, Inc.
  4. Lawrence F. Katz & Kevin M. Murphy, 1991. "Changes in Relative Wages, 1963-1987: Supply and Demand Factors," NBER Working Papers 3927, National Bureau of Economic Research, Inc.
  5. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn.
  6. Garicano, Luis & Hubbard, Thomas, 2007. "The Return to Knowledge Hierarchies," CEPR Discussion Papers 6077, C.E.P.R. Discussion Papers.
  7. Rosen, Sherwin, 1974. "Hedonic Prices and Implicit Markets: Product Differentiation in Pure Competition," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(1), pages 34-55, Jan.-Feb..
  8. Garicano, Luis & Hubbard, Thomas N, 2007. "Managerial Leverage Is Limited by the Extent of the Market: Hierarchies, Specialization, and the Utilization of Lawyers' Human Capital," Journal of Law and Economics, University of Chicago Press, vol. 50(1), pages 1-43, February.
  9. Luis Garicano & Esteban Rossi-Hansberg, 2006. "Organization and Inequality in a Knowledge Economy," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 121(4), pages 1383-1435, November.
  10. Epple, Dennis, 1987. "Hedonic Prices and Implicit Markets: Estimating Demand and Supply Functions for Differentiated Products," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 95(1), pages 59-80, February.
  11. David Card & John E. DiNardo, 2002. "Skill Biased Technological Change and Rising Wage Inequality: Some Problems and Puzzles," NBER Working Papers 8769, National Bureau of Economic Research, Inc.
  12. Luis Garicano, 2000. "Hierarchies and the Organization of Knowledge in Production," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 108(5), pages 874-904, October.
  13. Hartog,Joop & Maassen van den Brink,Henriƫtte (ed.), 2007. "Human Capital," Cambridge Books, Cambridge University Press, number 9780521873161, 9.
  14. David H. Autor & Lawrence F. Katz & Melissa S. Kearney, 2008. "Trends in U.S. Wage Inequality: Revising the Revisionists," The Review of Economics and Statistics, MIT Press, vol. 90(2), pages 300-323, May.
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Cited by:
  1. Bertrand Candelon & Arnaud Dupuy, 2012. "Hierarchical Organization and Performance Inequality: Evidence from Professional Cycling," Working Papers 2012/12, Maastricht School of Management.

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