Turbulent Firms, Turbulent Wages?

by Diego A. Comin, Erica L. Groshen & Bess Rabin

Overview — Has more creative destruction among firms raised wage volatility in the United States? Most of the related research on the remarkable and well-documented widening of wage inequality in the U.S. over the past three decades focuses on permanent components of workers' earnings, particularly the rising returns to education and ability associated with technological change, trade, and de-unionization. Less is known, however, about the contribution of larger transitory fluctuations. HBS professor Comin and colleagues explore whether workers' average pay is more volatile in firms that have experienced higher turbulence in sales. Findings have important implications for theories of labor markets and optimal wage compensation schemes. Key concepts include:

  • The performance of publicly-traded U.S. firms has become much more volatile over the past three decades.
  • Rising turbulence in sales among U.S. firms has raised their workers' wage volatility, increasing wage risks for many workers.
  • Workers' average pay is more volatile in firms that have experienced higher turbulence in sales. This is true even after controlling for firm characteristics, including average wage, average profits, size, age, or firm-specific fixed effects.
  • Evidence of a correlation between firm and wage volatility does not reflect reorganization within companies.
  • The effect is strong and has grown markedly since the 1980s. This reflects an increasing reliance of compensation schemes that put a larger weight on the firm performance.

Author Abstract

Has greater turbulence among firms fueled rising wage instability in the U.S.? Gottschalk and Moffitt [1994] find that rising earnings instability was responsible for one third to one half of the rise in wage inequality during the 1980s. These growing transitory fluctuations remain largely unexplained. To help fill this gap, this paper further documents the recent rise in transitory fluctuations in compensation and investigates its linkage to the concurrent rise in volatility of firm performance documented by Comin and Mulani [2006]. We find strong support for the hypothesis that rising high-frequency turbulence in the sales of large publicly-traded U.S. firms over the past three decades has raised their workers' high-frequency wage volatility. The evidence comes from two data sets: the Panel Study of Income Dynamics (detailed longitudinal information on workers), and COMPUSTAT (detailed firm information, plus average wage and employment levels). Through controls and instrumental variable probes, we rule out straightforward compositional churning as an explanation for the link between firm sales and wage volatility. We also observe that the relationship between sales and wage volatility at the firm level is stronger since 1980, is present only in large companies and is stronger in services than in manufacturing companies.

Paper Information