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Bias in Returns to Tenure When Firm Wages and Employment Comove: A Quantitative Assessment and Solution

Listed author(s):
  • Pedro Martins
  • Andy Snell
  • Heiko Stueber
  • Jonathan Thomas

It is well known that, unless worker-firm match quality is controlled for, returns to firm tenure (RTT) estimated directly via reduced form wage (Mincer) equations will be biased. In this paper we argue that even if match quality is properly controlled for there is a further pervasive source of bias, namely the co-movement of firm employment and firm wages. In a simple mechanical model where human capital is absent and separation is exogenous we show that positively covarying shocks (either aggregate or firm level) to firms employment and wages cause downward bias in OLS regression estimates of RTT. We show that the long established procedures for dealing with "traditional" RTT bias do not circumvent the additional problem we have identified. We argue that if a reduced form estimation of RTT is undertaken, firm-year fixed effects must be added in order to eliminate this bias. Estimates from two large panel datasets from Portugal and Germany show that the bias is empirically important. Adding firm-year fixed effects to the regression increases estimates of RTT in the two respective countries by between 3.5% and 4.5% of wages at 20 years of tenure -? over 80% (50%) of the estimated RTT level itself. The results extend to tenure correlates used in macroeconomics such as the minimum unemployment rate since joining the firm. Adding firm-year fixed effects changes estimates of these estimates also.

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File URL: http://webspace.qmul.ac.uk/pmartins/CGRWP64.pdf
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Paper provided by Queen Mary, University of London, School of Business and Management, Centre for Globalisation Research in its series Working Papers with number 64.

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Date of creation: Mar 2016
Handle: RePEc:cgs:wpaper:64
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  1. Sebastian Buhai & Miguel Portela & Coenraad N. Teulings & Aico Van Vuuren, 2008. "Returns to Tenure or Seniority?," CESifo Working Paper Series 2381, CESifo Group Munich.
  2. Beaudry, Paul & DiNardo, John, 1991. "The Effect of Implicit Contracts on the Movement of Wages over the Business Cycle: Evidence from Micro Data," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 665-688, August.
  3. Mark Gertler & Antonella Trigari, 2006. "Unemployment Fluctuations with Staggered Nash Wage Bargaining," Computing in Economics and Finance 2006 525, Society for Computational Economics.
  4. Bowlus, Audra J, 1995. "Matching Workers and Jobs: Cyclical Fluctuations in Match Quality," Journal of Labor Economics, University of Chicago Press, vol. 13(2), pages 335-350, April.
  5. Andy Snell & Jonathan Thomas, 2006. "Labour Contracts, Equal Treatment and Wage-Unemployment Dynamics," ESE Discussion Papers 144, Edinburgh School of Economics, University of Edinburgh.
  6. Joseph G. Altonji & Robert A. Shakotko, 1987. "Do Wages Rise with Job Seniority?," Review of Economic Studies, Oxford University Press, vol. 54(3), pages 437-459.
  7. Devereux, Paul J. & Hart, Robert A. & Roberts, J. Elizabeth, 2013. "Job Spells, Employer Spells, and Wage Returns to Tenure," IZA Discussion Papers 7384, Institute for the Study of Labor (IZA).
  8. Darren Grant, 2003. "The Effect of Implicit Contracts on the Movement of Wages over the Business Cycle: Evidence from the National Longitudinal Surveys," ILR Review, Cornell University, ILR School, vol. 56(3), pages 393-408, April.
  9. Pascal Michaillat, 2010. "Do Matching Frictions Explain Unemployment? Not in Bad Times," CEP Discussion Papers dp1024, Centre for Economic Performance, LSE.
  10. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, vol. 95(1), pages 50-65, March.
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