Academic journal article Economic Inquiry

Firm Size, Earnings, and Displacement Risk

Academic journal article Economic Inquiry

Firm Size, Earnings, and Displacement Risk

Article excerpt


Analogous to the well-documented firm size-wage differential, there also exists a differential in layoff risk according to firm size. Using Austrian data I discuss several reasons for this puzzle, including on-the-job training and workers' heterogeneity. If less stable (and also less able) workers select themselves into small, unstable, and low-paying firms, predicted layoff risk of workers can be used as a proxy for heterogeneity of workers and therefore be included in wage regressions. Doing this, one half of the size earnings premium can be explained. (JEL J31, J63)


Large employers pay more. Numerous empirical studies have documented this relationship, [1] but they have not been able to explain it. In a very careful study, Brown and Medoff (1989, 1056) look at ten possible reasons for this puzzle, only to conclude: "Our bottom line is that the size-wage differential appears to be both sizable and omnipresent; our analysis leaves us uncomfortably unable to explain it, or at least the part of it that is not explained by observable indicators of labor quality." Neither compensating differentials for working conditions nor product market power or the threat of unionization were able to explain the size premium. Brown and Medoff (1989) also found size effects for piece-rate workers, for unionized workers, [2] and in longitudinal samples [3] where they controlled by first-differencing for unobserved heterogeneity of the individuals.

Given this wide interest in the effects of employer size on earnings, very little research has been done concerning size differentials in turnover. Are the jobs in big firms not only higher paid but also more stable? This would reinforce the puzzle of firm size once more. Anderson and Meyer (1994) look at separation rates without distinguishing between quit and layoff and find highly decreasing turnover rates with firm size for permanent separations but no size effect on temporary separations. [4] Brown and Medoff (1989), as well as others, find quit rates to decline with firm size, which speaks against compensating wage differentials arguments. Idson (1996) explicitly looks at the issue of long-term employment relationships in large establishments, which may be possibly due to the greater capacity of large employers to provide job mobility within the enterprise and the lower probability of business failure facing larger firms. Rebitzer (1986) argues that the observed higher job tenure in large plants is in a ccordance with labor market segmentation theory.

The aim of this article is to provide further evidence for a size-layoff relationship using Austrian data. I try to consider several explanations for this regularity, especially on-the-job training and the hypothesis of selective recruitment of workers into large and small firms. Following one hypothesis, small employers attract less stable and capable employees, a pattern that would cause only a spurious size-layoff relationship. On the other hand, if workers with a relatively low stock of human capital sort themselves into relatively inefficient firms with unstable employment prospects, then the size-wage effect itself may be upwardly biased, which was noted by Mayo and Murray (1991). The plan of the article is as follows. Section II presents institutional details on wage bargaining and employment protection legislation in Austria. The data for the empirical study are discussed in section III. Results for size-wage and size-layoff relationships are presented in section IV. Section V looks at the interaction between firm size, layoff risk, and wage determination. Section VI concludes.


Wage bargaining in Austria is very centralized. Even though only about 60% of workers are organized in unions, bargaining outcomes are extended to all workers, unionized or not. A works council has to be established under the Austrian labor law in all establishments employing at least five adult workers, but usually the actual existence of a works council is positively determined by both firm size and firm age. …

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