Establishment Wage Differentials

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Introduction

Economists have long known that individual wages depend on a combination of employee and employer characteristics, as well as the interaction of the two. Although understanding whether establishment wage differentials, which say that an individual's pay is determined in part by the establishment at which they work, is important for labor economics and theories of the firm, little is known about the order of magnitude of this effect. This is primarily due to the lack of microdata which links individuals to the establishments where they work, but also due to technical difficulties associated with separating out employee and employer effects. This paper provides new information on establishment wage differentials by using data that permit both of these issues to be addressed. We exploit nationally representative microdata from the Occupational Employment Statistics program at the Bureau of Labor Statistics to calculate occupational and establishment wage differentials, the degree of occupational sorting across establishments, the importance of employer specific wage progression policies, and the importance of residual individual heterogeneity. These data contain information from more than half a million establishments, in all sectors of the economy, with wages reported for over 34 million individuals in more than 800 occupations. We believe that this paper contributes to the growing literature that seeks to understand the interactions between workers and their employers, and specifically the topic of employer effects on wages.

Our main contribution in this paper is the empirical estimates of how wages are influenced by the establishment at which the individual works. The decomposition of wages into employee and employer effects, which is based on similar work by Groshen (1991b) and Bronars and Famulari (1997), uses OLS regressions to partition the sum of squares of wages into worker and establishment components. Our results show that employer effects contribute substantially to earnings differences -- the results from our basic model show that controlling for detailed occupation, establishment dummies account for 21 percent of individual wage variation. These employer effects can only be partially explained by observable establishment characteristics such as location, size, age, and industry.

However, our data permit us to do more than this. The theoretical literature has predicted that team production will result in the sorting of workers of similar skill within establishments (Kremer, 1993). We examine this one step further by examining the correlations of occupational wages within establishments. The theoretical motivation for this analysis is based on team production models, such as Kremer (1993), which predict that workers of similar skill will match together in establishments. The goal of our correlation analysis is to examine the breadth of the establishment wage differentials across occupations. Our results are striking -- we find that establishments that pay well for one occupation also pay well for others. Even after controlling for observable establishment characteristics, we find positive wage correlations within establishments for occupations that are closely related, as well as for occupations that one would not expect to be closely related in the production process.

We conclude with a discussion of how our results fit into and expand the current literature, both with respect to what we know and what we don't know. We point out how our empirical work presents new stylized facts to guide future theoretical and empirical work regarding establishment wage differentials.

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The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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