How Much Should we Trust Estimates of Firm Effects and Worker Sorting?
Many studies use matched employer-employee data to estimate a statistical model of earnings determination where log-earnings are expressed as the sum of worker effects, firm effects, covariates, and idiosyncratic error terms. Estimates based on this model have produced two influential yet controversial conclusions. First, firm effects typically explain around 20% of the variance of log-earnings, pointing to the importance of firm-specific wage-setting for earnings inequality. Second, the correlation between firm and worker effects is often small and sometimes negative, indicating little if any sorting of high-wage workers to high-paying firms. The objective of this paper is to assess the sensitivity of these conclusions to the biases that arise because of limited mobility of workers across firms. We use employer-employee data from the US and several European countries while taking advantage of both fixed-effects and random-effects methods for bias-correction. We find that limited mobility bias is severe and that bias-correction is important. Once one corrects for limited mobility bias, firm effects dispersion matters less for earnings inequality and worker sorting becomes always positive and typically strong.
We thank audiences at various conferences and seminars for useful comments. The opinions expressed in this paper are those of the authors alone and do not reflect the views of the Internal Revenue Service, the US Treasury Department, or the National Bureau of Economic Research. We thank SOI, Statistics Norway, the IFAU and Statistics Sweden, the Fondazione Rodolfo De Benedetti, as well as the Austrian Labor Market Service and the Austrian Federal Ministry for Social Affairs, Health, Care and Consumer Protection for granting access to all data sources. This work is a component of a larger project on income risk in the United States, conducted through the SOI Joint Statistical Research Program. Mogstad and Setzler acknowledge funding from NSF Grant SES-1851808. Bonhomme, Lamadon and Manresa acknowledge funding from NSF Grant SES-1658920.
Stéphane Bonhomme & Kerstin Holzheu & Thibaut Lamadon & Elena Manresa & Magne Mogstad & Bradley Setzler, 2023. "How Much Should We Trust Estimates of Firm Effects and Worker Sorting?," Journal of Labor Economics, vol 41(2), pages 291-322.