A job at a large company used to bring with it several advantages, not the least of which was generally higher pay than similar employees working at a smaller firm. Called the firm-size wage effect, the phenomenon has been extensively studied by economists and sociologists as it has eroded in the last three decades and affected everything from employer-employee relationships to income inequality.

But what was less known is what segment of workers suffered the most under the erosion of the wage effect, and how much that erosion exacerbated the growing income inequality in the U.S.

 

Hard work
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New research co-authored by Wharton management professor Adam Cobb has provided the answer. In his paper, “Growing Apart: The Changing Firm-Size Wage Effect and Its Inequality Consequences,” Cobb and co-author Ken-Hou Lin of the University of Texas at Austin found that workers in the middle and bottom of the wage scales felt the biggest negative effects from the degradation of the link between firm size and wages. Those at the top of the wage scale, however, experienced no loss in the large-firm wage premium.

Moreover, the uneven erosion of the firm-size wage effect explains around 20% of rising wage inequality during the study period of 1989 to 2014 — a testament, Cobb says, to the impact large firms have on rising inequality.

“Working for a big, stable company would have typically been seen as a fantastic career decision — there’s opportunity for advancement and good wages,” Cobb says. “That no longer seems to be the case. The advantages of working in a large firm have really declined in some meaningful ways.”

A Changing Distribution

Previous research cited by Cobb in his paper shows that firms with 500 or more workers once paid wages that were 30% to 50% higher than those firms with fewer than 25 workers. Large companies paid premiums to attract higher-quality workers (a result of the higher cost of screening and monitoring hires) and the wage floor was likely driven up by organized labor or, for those companies that were unionization-averse, attempts to sweeten the wage pot enough that employees would see no need to organize.

The wage effects existed throughout the company, Cobb says, including support personnel working jobs that are now regularly outsourced. Hiring processes were standardized and employees moved more or less in lockstep through wage bands that essentially ensured a robust pay for long-term workers.

“Imagine 40 years ago you were an administrative assistant, janitor or security guard [at a large firm]. You probably got paid pretty well compared to those in the same job working for smaller firms,” Cobb notes. “[Large firms] definitely had an internal labor market-style system of wage setting that relied on job evaluations and other forms of standardization.”

Using two sets of federal data, the researchers examined the distribution of firm-size wage effect across wage levels and over time. According to their analysis, all levels of employees benefitted from the big firm bonus, although the premiums were significantly higher for individuals at the bottom and middle of the wage distribution curve.

Despite the recent national conversations about economic inequality, the changes in firm-size wage effect are not recent. Cobb said they started in the 1980s but took off during the subsequent economic boon of the 1990s.

“It was the same time that the outsourcing and offshoring of low-wage jobs started to take effect,” he says. “Layoffs have happened forever, but now you see firms that are actually very profitable downsizing. Additionally, many firms have outsourced low- and mid-wage workers, so now they work for contracting companies and get paid a lot less.”

“The advantages of working in a large firm have really declined in some meaningful ways.”

Broader changes in the marketplace also exacerbated the change, Cobb says, including globalization, technology changes and a change in the relationship between employer and employee. Pay, once linked to the job, became linked to the individual worker and did not increase in the same predetermined pattern. Frontline managers, for example, had more discretion on what to pay and who to hire, functions that once would have been part of the centralized hiring process common at large firms.

“When you combine all these things, the rewards for working in a large firm have seemingly changed and they have changed more dramatically for lower- and middle-skilled workers,” Cobb says.

While the U.S. data helped Cobb identify the pay bands most affected by the change in the wage effect, it didn’t show him precisely which factors within a company led to the decline. His next step in this research will be examining just that, using Canadian data to look at the distribution of wages inside firms to see how factors like the adoption of technology, globalization and changing unionization rates play a role.

“That would give us a better look at how these get translated into different pay-setting practices inside firms,” he says.