Explaining Earnings Inequality

The paper presented in this ZEW Research Seminar studies whether inequality in earnings across firms can be explained, in part, by differences in the non-wage amenities of a job. The authors develop and implement an empirical framework to measure the value to workers of the non-wage amenity component of firm pay – in dollar terms. They find that the variance of total compensation at the firm level is twenty times that of firm pay. At the individual level, they find that the variance in total job value is six times larger than the variance of wages alone. Using a simple model where wage and non-wage amenity components of firm pay are determined endogenously by cost-minimizing firms, they construct a counterfactual exercise to measure the role of compensating differentials in inequality in firm pay. The authors find that while there is evidence for compensating differentials, shutting down the compensating differentials motive increases the variance in firm pay for reasonable parameter values, rather than decreases it. They also find evidence for dispersion in utility pay and therefore, of rents in the labor market.  Examining implications for the gender gap, they find that the gender gap in total utility compensation is augmented four-fold by taking into account the role of compensating differentials and the value of non-wage amenities.