Wage Inequality and Firm Growth By HOLGER M. MUELLER, PAIGE P. OUIMET, AND ELENA SIMINTZI*

* Mueller: New York University, Stern School of Business, 44

inequality, CEO pay has risen significantly

West Fourth Street, New York, NY 10012, NBER, CEPR, and ECGI (e-mail: [email protected]); Ouimet: University of North Carolina at Chapel Hill, Kenan-Flagler Business School, Campus Box 3490,

McColl

Building,

Chapel

Hill,

NC

27599

over the past decades. Terviö (2008) and Gabaix and Landier (2008) link the rise in

(e-mail:

[email protected]); Simintzi: University of British Columbia, Sauder School of Business, 2053 Main Mall, Vancouver, BC, V6T

CEO pay to changes in the size of the largest firms in the economy. As the authors show,

1Z2, Canada (e-mail: [email protected]). The authors are

the sixfold increase in CEO pay between 1980

grateful to Nick Bloom (discussant) for helpful comments.

While the dramatic rise in wage inequality over the past decades has been the topic of much research, its causes are still not perfectly understood. 1 In this and our companion paper (Mueller, Ouimet, and Simintzi 2016), we focus on the role of firms. After all, wages are paid by firms. Accordingly, understanding wage inequality at the firm level may shed light on its causes and ultimately may help us understand better trends in aggregate wage

attributed to the sixfold increase in the size of the largest companies during that period. In addition, variation in CEO pay closely tracks variation in firm size in the cross-section as well as across countries. Terviö (2008) and Gabaix and Landier (2008) both argue that the link between CEO pay and firm size is consistent with the efficient assignment of CEOs in market equilibrium. Building on Rosen’s (1981)

inequality. Mainly due to data availability, much of the empirical literature on pay practices at the firm level has focused on pay at the very top of the firm’s hierarchy: CEO compensation.

and 2003 in the United States can be fully

2

Along with the rise in aggregate wage

1 See Acemoglu and Autor (2011) and Atkinson, Piketty, and Saez (2011) for reviews of the literature. For recent empirical examinations of wage inequality in the United States and elsewhere, see, e.g., Card, Heining, and Kline (2013), Barth et al. (2016), Alvarez et al. (2016), and Song et al. (2016). 2 Friedman and Jenter (2010) and Edmans and Gabaix (2016) provide detailed reviews of the CEO pay literature.

economics of superstars, the authors suggest that “the economic impact of a manager’s decisions depends on the amount of resources under his control” (Terviö 2008, p. 642). 3 Accordingly, efficient matching posits that more talented CEOs should match with larger

3

See also Rosen (1982, p. 311): “Assigning persons of superior talent to top positions increases productivity by more than the increments of their abilities because greater talent filters through the entire firm by a recursive chain of command technology. These multiplicative effects support enormous rewards for top level management in large organizations.”

firms, implying that CEOs’ equilibrium pay is

changes in firm size can potentially explain

increasing with firm size.

trends in aggregate wage inequality, akin to

Although the rise in CEO pay over the past

the arguments made by Terviö (2008) and

decades has been spectacular, it can hardly

Gabaix and Landier (2008) in the context of

explain the rise in aggregate wage inequality.

CEO compensation.

Indeed,

commonly

used

measures

of

aggregate wage inequality, such as the 90/10

I. More Pay Inequality at Larger Firms

log wage differential, are unlikely to be much

In our companion paper (Mueller, Ouimet,

affected by CEO pay given that the income of

and Simintzi 2016), we explore the relation

th

most CEOs lies comfortably above the 90

between within-firm pay inequality and firm

percentile of the aggregate wage distribution.

size using firm-level survey data on employee

However, this does not mean that the link

pay for a broad cross-section of private and

between firm size, managerial talent, and pay

public firms in the United Kingdom for the

proposed by Terviö (2008) and Gabaix and

period from 2004 to 2013. Our final sample

Landier (2008) cannot be useful in explaining

consists of 880 firms. The survey data are

wage inequality more broadly. Many jobs

provided by Income Data Services (IDS), an

within a firm involve managerial skills and

independent research and publishing company

responsibilities. If more talented managers

specializing in the field of employment.

match with larger firms, then we should see

Important for our purposes, employers are

pay increasing with firm size not only at the

asked to group job titles into broad hierarchy

very top of the firm’s hierarchy but also in

levels based on required skills and tasks,

other hierarchy levels where managerial talent

including managerial responsibilities. Hence,

is important. By contrast, the pay of lower-

if a particular job title has different meanings

level employees should be largely invariant

at different firms (e.g., different managerial

with respect to firm size given that the actions

responsibilities), then it will be assigned to

of these employees are less scalable across the

different hierarchy levels.

firm. Taken together, these arguments imply

To give some examples, hierarchy level 1,

that pay differentials between top- and

our lowest hierarchy level, includes work that

bottom-level jobs within a firm should be

“requires basic literacy and numeracy skills

increasing with firm size. Lastly, if pay

and

inequality increases with firm size, then

straightforward

the

ability and

to

perform

short-term

a tasks

few to

instructions under immediate supervision.”

when lower hierarchy levels are compared to

Typical job titles are cleaner, laborer, and

one another, an increase in firm size has no

unskilled worker. By contrast, hierarchy level

significant

9, our highest hierarchy level, includes “very

inequality.

effect

on

within-firm

pay

substantial

Also, whenever the coefficient on firm size

experience in, and leadership of, a specialist

is significant, it is monotonically increasing in

function,

the

the pay ratio. For instance, moving from the

organisation’s overall strategy.” Typical job

25th to the 75th percentile of the firm-size

titles are HR director, finance director, and

distribution raises the pay associated with

head of legal.

hierarchy level 9 by 280.1% relative to the pay

senior

executive

roles

including

with

some

input

to

To obtain measures of within-firm pay

associated

with

hierarchy

level

1.

By

inequality, we compute for all (9×8)/2 = 36

comparison, the pay associated with hierarchy

hierarchy-level pairs the ratio of average

level 6 increases (only) by 59.7%, that

wages within a given firm and year (“pay

associated with hierarchy level 7 increases by

ratio”). For example, pay ratio 19 compares

138.2%, and that associated with hierarchy

the average pay of top-level executives, such

level 8 increases by 253.3%—all relative to

as finance and HR directors, with that of

the pay associated with hierarchy level 1.

employees at the bottom of the firm’s

Hence, a given increase in firm size has a

hierarchy, such as cleaners and unskilled

roughly 4.7 times bigger impact on pay ratio

workers, within the same firm and year.

19 than it has on pay ratio 16. (The complete

In order to examine the relation between within-firm pay inequality and firm size, we

set of results is described in Mueller, Ouimet, and Simintzi 2016.)

regress each pay ratio on the number of firm-

In sum, our results show that larger firms

level employees. Thus, we run 36 separate

exhibit significantly more pay inequality:

regressions. In spite of the large number of

wage differentials between top- and bottom-

regressions, our results reveal a remarkably

level

clear pattern. When higher hierarchy levels (6

between different top-level jobs—are all

to 9) are compared to either one another or

increasing with firm size. By contrast, wage

lower

pay

differentials comparing lower hierarchy levels

differentials between different hierarchy levels

to one another are invariant with respect to

are increasing with firm size. By contrast,

firm size. Hence, an HR director’s pay (level

hierarchy

levels

(1

to

5),

jobs—but

also

wage

differentials

9) increases relative to the pay of an unskilled

some of the rise in aggregate wage inequality

worker (level 1) as firm size increases.

over time. To address this question, we have

However,

ordinary

gathered wage data for a large number of

HR/Personnel officer (level 4) does not

developed countries. 4 The data are provided

increase relative to the pay of an unskilled

by LIS, formerly known as The Luxembourg

worker. Our results are consistent with

Income Study. LIS data are particularly well

theories emphasizing the efficient assignment

suited for our purposes as they use official

of managerial talent: while pay inequality is

data collected from individual countries’

increasing with firm size, the result is entirely

statistical offices. The data include labor

driven by hierarchy levels where managerial

income for a broad cross-section of employees

skills and responsibilities are important.

in a given country and year. We limit our

the

pay

of

an

Can our analysis say something about the

sample to full-time employees by excluding

possible causes of rising wage inequality over

employees identified as part-time and those

time? To address this issue, we focus on

that report working less than 35 hours per

within-firm variation by including firm fixed

week.

effects. That is, we examine the relation

employees in a given country and year, we

between changes in pay inequality at the firm

estimate the 10th and 90th percentiles of the

level and firm growth. Consistent with our

aggregate wage distribution. Our measure of

cross-sectional results, we find that wage

aggregate wage inequality is the commonly

differentials between top- and bottom-level

used 90/10 log wage differential.

Using

the

sample

of

full-time

jobs—but also wage differentials between

We source firm-size data from Thomson

different top-level jobs—become significantly

Reuters’ Worldscope. Worldscope provides

larger as firms grow over time. By contrast,

data on firm fundamentals for publicly listed

wage differentials comparing lower hierarchy

firms in many countries. Similar to the

levels to one another are unrelated to firm

analyses in Terviö (2008) and Gabaix and

growth.

Landier (2008), we focus on the largest firms in a given country. (This is also consistent

II. Wage Inequality and Firm Growth in Developed Countries The within-firm analysis raises the question of whether firm growth can possibly explain

4

The cross-country analysis described in this section is not part of our companion paper (Mueller, Ouimet, and Simintzi 2016). In our companion paper, we focus entirely on UK firms. In addition to showing that high-inequality firms are larger, we also show that they exhibit better operating performance, higher valuations, and larger equity returns, consistent with the notion that higher pay inequality is a reflection of better managerial talent.

with our firm-level analysis in Section I: the

Table 2 examines the relationship between

average firm in our UK sample has 10,014

aggregate wage inequality, expressed through

employees.) Specifically, we calculate the

the 90/10 log wage differential, and the

average number of employees for either the 50

average number of employees (in logs) of the

or 100 largest firms in a given country and

50 (100) largest firms in a country. The

year. LIS data are not available for every year

regressions in columns (1) and (4) include

and, for most countries, there is a gap of

country and year fixed effects. As is shown,

several years between surveys. On average,

there is a positive and significant association

we have wage data for six different years for

between changes in wage inequality and

the countries in our sample. Our final sample

employment growth by the largest firms in a

consists of all countries for which we have

country. The regressions in columns (2), (3),

both wage data and firm-size data: Australia,

(5), and (6) include country fixed effects but

Austria, Belgium, Canada, Denmark, Finland,

no year fixed effects. Instead, they include a

France, Germany, Greece, Italy, Netherlands,

linear time trend defined as the given year

Spain, Sweden, United Kingdom, and United

minus 1999. In columns (2) and (5), the

States.

positive coefficient on the time trend is reflective of the rise in aggregate wage [ Insert Table 1 Here ]

inequality

during

the

sample

period.

Table 1 shows for each country the sample

Importantly, in columns (3) and (6), adding

period, number of country-year observations,

firm growth to the regression reduces the

and change in average employment among the

coefficient on the time trend by 36.1% and

50 (100) largest firms during the sample

39.8%, respectively. Consequently, part of

period. As can be seen, firm growth is

what may be perceived as a global trend

pervasive among large publicly listed firms

toward more wage inequality may be driven

during the sample period. With the exception

by an increase in the size of the largest firms

of

in the economy.

Denmark,

the

change

in

average

employment among the top 50 (100) firms is

III. Conclusions

positive in all countries. We discuss firm-level evidence based on [ Insert Table 2 Here ]

UK data showing that within-firm pay inequality increases with firm size. Moreover,

as firms grow larger over time, within-firm

the Rise of West German Wage Inequality.”

pay inequality rises. Lastly, using wage data

Quarterly Journal of Economics 128 (3):

from 15 developed countries, we document a

967—1015.

positive association between aggregate wage

Edmans, Alex, and Xavier Gabaix. 2016.

inequality at the country level and growth by

“Executive

Compensation:

A

Modern

the largest firms in the economy.

Primer.” Journal of Economic Literature 54 (4): 1232—87.

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TABLE 1— FIRM GROWTH IN DEVELOPED COUNTRIES Top 50 Firms

Top 100 Firms

Country

Sample Period

Obs.

Change in Firm Size

Sample Period

Obs.

Change in Firm Size

Australia

1985 - 2001

4

37.1%

1995 - 2001

2

16.2%

Austria

1994 - 2004

4

82.8%

1997 - 2000

2

18.3%

Belgium

1988 - 2000

5

112.2%

1992 - 2000

4

35.4%

Canada

1981 - 2010

10

73.1%

1981 - 2010

10

80.7%

Denmark

1995 - 2010

5

-2.1%

1995 - 2010

5

-4.3%

Finland

1987 - 2010

7

58.6%

1991 - 2010

5

46.7%

France

1994 - 2005

3

48.3%

1994 - 2005

3

40.3%

Germany

1984 - 2010

7

91.0%

1984 - 2010

7

87.3%

Greece

1995 - 2010

5

192.6%

1995 - 2010

5

201.7%

Italy

1987 - 2010

10

31.5%

1987 - 2010

10

30.3%

Netherlands

1983 - 2010

8

107.9%

1987 - 2010

7

87.1%

Spain

1995 - 2010

5

200.3%

1995 - 2010

5

185.9%

Sweden

1987 - 1995

3

13.6%

1987 - 1995

3

15.5%

United Kingdom

1986 - 2010

8

51.3%

1986 - 2010

8

43.5%

United States

1986 - 2010

8

55.8%

1986 - 2010

8

53.0%

TABLE 2— AGGREGATE WAGE INEQUALITY AND FIRM GROWTH

(1) Firm Size

Top 50 Firms (2)

0.211*** (0.0739)

Time Trend

Observations R-squared

(3)

(4)

0.145**

0.206***

(0.0671)

(0.0609)

Top 100 Firms (5)

(6) 0.183*** (0.0562)

0.0104***

0.00656***

0.0111***

0.00668***

(0.00139)

(0.00193)

(0.00127)

(0.00172)

92

92

92

84

84

84

0.892

0.857

0.863

0.944

0.914

0.923

Notes: The dependent variable is the 90/10 log wage differential. Firm size is the average number of employees (in logs) of the 50 or 100 largest firms in the country. If there are fewer than 100 firms with available employment data in a given country and year, the country-year observation is dropped from the top 100 sample. Time trend is the given year minus 1999. All regressions include country fixed effects. Those in columns (1) and (4) additionally include year fixed effects. Robust standard errors are in parentheses. *** Significant at the 1 percent level. ** Significant at the 5 percent level. * Significant at the 10 percent level.