Wage Dispersion, Compensation Policy and the Role of Firms
November 2005
Working Paper Number:
tp-2005-04
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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:
econometrically,
estimation,
economist,
econometric,
estimating,
payroll,
model,
earnings,
employee,
employ,
employed,
unobserved,
discrimination,
employing,
econometrician,
employment wages,
wage variation,
wage data,
earn,
compensation
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including "organizations." By filtering for frequent words and phrases labeled as "organizations", papers are
identified to contain references to specific institutions, datasets, and other organizations.
:
Standard Industrial Classification,
Social Security Administration,
Ordinary Least Squares,
American Immigration Council,
Retail Trade,
Employer Identification Numbers,
Longitudinal Employer Household Dynamics,
LEHD Program,
Protected Identification Key,
Employer-Household Dynamics,
Quarterly Census of Employment and Wages,
NUMIDENT
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