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

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  • Pedro Martins
  • Andy Snell
  • Heiko Stueber
  • Jonathan Thomas

Abstract

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 show 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 firm?s 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 fi?xed 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 effects also. JEL codes:

Suggested Citation

  • Pedro Martins & Andy Snell & Heiko Stueber & Jonathan Thomas, 2016. "Bias in Returns to Tenure When Firm Wages and Employment Comove: A Quantitative Assessment and Solution," FEUNL Working Paper Series wp601, Universidade Nova de Lisboa, Faculdade de Economia.
  • Handle: RePEc:unl:unlfep:wp601
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    References listed on IDEAS

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    1. Alberto Martin, 2008. "Adverse selection, credit and efficiency: The case of the missing market," Economics Working Papers 1085, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 2009.
    2. 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).
    3. 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.
    4. I. Sebastian Buhai & Miguel A. Portela & Coen N. Teulings & Aico van Vuuren, 2014. "Returns to Tenure or Seniority?," Econometrica, Econometric Society, vol. 82(2), pages 705-730, March.
    5. 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.
    6. Pascal Michaillat, 2012. "Do Matching Frictions Explain Unemployment? Not in Bad Times," American Economic Review, American Economic Association, pages 1721-1750.
    7. Pascal Michaillat, 2012. "Do Matching Frictions Explain Unemployment? Not in Bad Times," American Economic Review, American Economic Association, pages 1721-1750.
    8. Andy Snell & Jonathan P. Thomas, 2010. "Labor Contracts, Equal Treatment, and Wage-Unemployment Dynamics," American Economic Journal: Macroeconomics, American Economic Association, pages 98-127.
    9. Mark Gertler & Antonella Trigari, 2006. "Unemployment fluctuations with staggered Nash wage bargaining," Proceedings, Federal Reserve Bank of San Francisco.
    10. Mark Gertler & Antonella Trigari, 2009. "Unemployment Fluctuations with Staggered Nash Wage Bargaining," Journal of Political Economy, University of Chicago Press, pages 38-86.
    11. 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.
    12. 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.
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    Cited by:

    1. Martins, Pedro S., 2016. "Should the Maximum Duration of Fixed-Term Contracts Increase in Recessions? Evidence from a Law Reform," IZA Discussion Papers 10206, Institute for the Study of Labor (IZA).

    More about this item

    JEL classification:

    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models

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