Does Firm Size Matter Anymore? The New Economy and Firm Size Wage Effects

Abstract

Researchers have long known that large firms pay higher wages than small firms for workers with similar measured characteristics; however, an agreed-upon explanation for this firm size wage effect (FSWE) has not been reached. Recent changes in the economy provide new leverage for testing competing theories for the effect, while questions about the existence and nature of the “New Economy” provide new motivation for exploring this topic. This study uses the 1988-2003 Current Population Survey and finds that the FSWE has declined by about one third over the study period. Examining the competing explanations for the FSWE, this study finds that while the sorting of workers by traits, unions, and industry factors all contribute to some portion of the effect in cross-section, they fail to explain why it has declined over time. Market power explanations also fail to find support. Shifts in organizational structures, particularly a decline of internal labor markets, appear to best fit the results. These findings provide supporting evidence for the “New Economy” and the idea that recent decades have brought about significant changes within organizations and in employment opportunities.

Growing Apart: The Changing Firm-Size Wage Premium and Its Inequality Consequences

“…A common theme among these accounts is the idea that the FSWE is a proxy for a factor (or factors) that are typically unobserved with existing data (Hollister 2004). The more prominent theories, which we briefly summarize below, are based upon size-related differences in human capital, monitoring costs, monopoly power, union effects, and organizational structures.…”

“…Other scholars have argued that the FSWE is due to differences in the types of employment practices and organizational structures used by large firms (e.g., Hollister 2004). Previous research has found firm size to be strongly correlated with organizational practices such as formalization, training, and internal labor markets (Aldrich and Marsden 1988;Kalleberg and Van Buren 1996).…”

“…For example, Hollister (2004) found that the FSWE declined by about one-third between 1988 and 2003, and that while human capital characteristics can explain some portion of the FSWE in the cross-section, they do not explain the decline over time. Shifts in organizational structures, particularly the decline in internal labor markets (ILMs), however, do help explain the decline.…”

“…There is also evidence that the FSWE was higher for those with lower levels of education (Even and Macpherson 2012;Hollister 2004) and that ILMs provided higher wage premiums for lowerskilled workers than higher-skilled ones (Groshen and Levine 1998), suggesting also that lowerand middle-wage employees benefited disproportionately from large-firm employment. Taken together, we expect that in a desire to maintain perceptions of equity, large firms will be particularly apt to vertically compress wages by raising the wage floor for lower-and middle-wage workers, such that the FSWE will be higher for lower-and middle-wage workers than their higherwage counterparts.…”

“…Though prior research has yet to examine this question directly, it has offered some important clues. For example, research has found that the FSWE is greater for lesseducated versus higher-educated workers (e.g., Even and Macpherson 2012;Hollister 2004), suggesting that large firms compress wages, and more generally that firm-size wage premiums vary across the wage distribution. Moreover, research has chronicled a steady decline in the FSWE (e.g., Hollister 2004), suggesting that the benefits of large-firm employment may be decreasing.…”