Small firms may offer higher pay due to a lack of market power

Small companies may post higher wages for entry level positions than large companies—potentially attracting better talent, even though the larger companies have more influence on the market, according to new Cornell research.

“When firm productivity and worker skills are complementary, we actually want to see more-skilled workers at more-productive firms,” said Thomas Jungbauer, assistant professor of strategy and business economics in the Samuel Curtis Johnson Graduate School of Management, part of the SC Johnson College of Business.

And when firms hire similar numbers of workers, or when the applicant pool is large enough, we do in fact expect more-productive firms to post higher wages, thereby attracting more-qualified workers.

“But in high-skill labor markets, with a limited set of workers to choose from, market power matters,” he said, “because vacant positions within larger firms rival each other for workers.”

This rivalry may lead to mismatch through lower wages at big firms, according to Jungbauer, author of “Strategic Wage Posting, Market Power, and Mismatch,” published in the Journal of Labor Economics.

The other key finding: The benefits of offering different wages for the same job openings within a company are limited. “Even the small benefits of equal starting wages—from avoiding tensions or haggling over salaries—may compel firms not to post different wages for their vacancies,” he said.

Jungbauer began pondering this line of research nearly a decade ago, as a Ph.D. student at Northwestern University’s Kellogg School of Management. He was bothered, he said, by the fact that most of the research in this area only looked at one-to-one models, in which each firm hires a single worker, as opposed to scenarios in which firms have varying numbers of openings, and thus differ in their market power as is common in real-world labor markets.

“I was just irked by the fact that you have a model which doesn’t take into account that firms hiring needs are often very different for a myriad of reasons,” he said, “but all the early models assumed that every firm is hiring one worker.”

Jungbauer shows that when worker skills are fairly uniformly distributed, firms are indifferent between posting equal wages for all their openings and posting different wages. He shows that the presence of the above-mentioned labor market power, that is, firms hiring different numbers of workers, may have detrimental effects on the distribution of workers across firms.

More-productive firms may hire less-skilled workers than their smaller competitors because of a lack of “within-firm rivalry,” according to Jungbauer.

“While the openings of larger firms rival each other for workers,” he said, “these vacancies do not bid against each other, translating into lower wages in equilibrium.”

“If I’m a big firm, I’m hurting all my other vacancies if I post a higher wage,” Jungbauer said. “In equilibrium, I have less of an incentive to post high wages than a small firm with a single opening for example.”

Despite firms with more vacancies hiring less-skilled workers, Jungbauer finds, equilibrium wages are such that more productive firms always accrue higher profits. And added profit per worker decreases, so firms may want to reduce the number of their vacancies in order to obtain more-skilled workers.

It would stand to reason that the bigger, more productive firms got that way by hiring superior talent, but that’s not necessarily true, according to Jungbauer.

“A lot of market power initially originates from the output side,” he said. “Take Amazon, for example. A top entrepreneurial idea coupled with excellent execution exploded and much of the resulting market power translated to the input side.”