Firms, Assignments, and Earnings

T he U.S. distribution of labor earnings is highly skewed to the right. Roughly, the lowest 50 percent of U.S. households, as measured by individual labor earnings, make 10 percent of total labor earnings. The next lowest 30 percent earn approximately 30 percent and highest 10 percent make 40 percent.1 Earnings are also related to a person’s position within a firm and employment at a particular firm. Within a firm earnings tend to be associated with rank. The higher is an individual’s authority and control, the higher is his compensation. The most extreme manifestation of this is the enormous pay of the top executives of large firms. In 1996 the median pay of chief executive officers of companies in the S&P 500 index was nearly 2.5 million dollars (Murphy 1999). Across firms earnings tend to increase with firm size. This is particularly true for executives. The elasticity of executive pay with respect to firm size is in the range of 0.20 to 0.35 (Rosen 1992). Earnings for workers also increase with firm size. This is the well-documented wage-size premium (Brown and Medoff [1989] and Oi and Idson [1999]). The standard neo-classical production function, where output equals a function of aggregate labor and aggregate capital, cannot simultaneously account for these facts. It can generate an unequal distribution of earnings, if some people’s labor is more efficient than others. But it has only one economywide firm so it is necessarily silent on any relationship between earnings and firm assignments. And even with respect to the distribution of earnings, the