Wage and Productivity Dispersion: The Roles of Rent Sharing, Labor Quality and Capital Intensity

Firm labor productivity and average wages paid by firms vary considerably and are positively correlated. These observations can be rationalized either by exogenous TFP heterogeneity in firm productivity coupled with rent sharing or by differences in capital intensity and in the quality of labor inputs. This paper ascertains the extent to which these factors provide an explanation of the observations using Danish matched employer-employee data. Using the worker fixed effect in a wage equation as a measure of worker ability, and a combination of ability and occupational composition for labor force quality, we find that TFP heterogeneity explains more of the observed labor productivity dispersion than differences in capital intensity and labor force quality in each of the industries considered, and that variation in labor force composition explains more than ability differences. Both differences in labor force quality and rent sharing are important in explaining firm level wage dispersion, whereas rent sharing is most important for the positive correlation between average firm wage and labor productivity.