Is Bigger Still Better? The Decline of the Wage Premium at Large Firms

[Author Affiliation]William E Even, , , , evenwe@muohio.eduDavid A Macpherson, , , , david.macpherson@trinity.edu[Acknowledgment]We thank Daniel Becker, Christopher Bollinger, and Barry Hirsch for helpful comments.1. IntroductionLarge firms pay higher wages than small firms. This fact was first documented nearly 100 years ago and has been confirmed by myriad studies since then. Considerable effort has been directed toward testing different theoretical explanations for the size premium. These include the fact that larger firms employ a more skilled work force and provide them with more and better capital; pay efficiency wages to deal with greater monitoring costs; pay compensating differences for less pleasant working conditions or greater risk that results from the type of human capital that is acquired; or share rents with workers because of union threats or monopoly profits.While there has been extensive research attempting to determine the importance of these different explanations of the size premium, a recent trend has gone unnoticed. Namely, the firm size premium has fallen substantially over the past 20 years. For example, we show that workers in firms with over 500 workers earned 55% more than workers in firms with fewer than 25 workers in the early 1990s. Our most recent data indicate that the size premium dropped by 15 percentage points over the past 20 years. We also show that the size premium fell much more rapidly among less educated workers. For example, among workers with less than a high school degree, the size premium fell by 30 percentage points. This study documents the trends in the size premium and explores some possible explanations for the trends.Section 2 provides an overview of the theoretical explanations and empirical evidence on the size premium. In section 3 we discuss our data and review the evidence on trends in the size premium. Empirical analysis of the trends is provided in section 4. Our main conclusions are as follows: First, the size premium dropped over the past 20 years for two primary reasons: (i) The type of worker employed by large and small firms has become more similar over time, and (ii) large and small firms have become more similar in terms of the ways in which they reward workers, holding observed characteristics constant. In addition, while the size premium has diminished over time, it remains quantitatively significant--particularly among highly educated workers.2. BackgroundOi and Idson (1999) provide a wide-ranging summary of the extant research on the size premium. Their review points out that the size premium was first documented nearly 100 years ago among female workers at textile firms. Their summary of empirical studies shows that the largest firms (e.g., firms with 500 or more employees) pay wages that are 30-50% higher than those of the smallest firms (e.g., firms with fewer than 25 employees).Numerous theories for the size premium have been proposed, and no single theory is capable of providing an empirical explanation for the entire size premium. The more prominent theories for the size premium are based upon size-related differences in monitoring costs, capital/technology, working conditions, monopoly power, or union effects.The monitoring costs explanation for the size premium, first proposed by Oi (1983), argues that greater monitoring costs at large firms cause them to hire more able workers to conserve on monitoring costs. Because larger firms hire more able workers, wages increase with firm size. In addition, because of greater monitoring costs, large firms may be more likely to pay efficiency wages or deferred pay to reduce monitoring problems and utilize higher capital-labor ratios to conserve on the number of workers. Empirical evidence indicates that the greater use of advanced technology by large firms explains part of the size premium (Dunne and Schmitz 1995; Reilly 1995; Tan and Batra 1997; Troske 1999; Yu et al. …