Equilibrium Wage Dispersion with Worker and Employer Heterogeneity

We construct and estimate an equilibrium search model with on–the–job–search. Firms make take–it–or–leave–it wage offers to workers conditional on their characteristics and they can respond to the outside job offers received by their employees. Unobserved worker productive heterogeneity is introduced in the form of cross–worker differences in a “competence” parameter. On the other side of the market, firms also are heterogeneous with respect to their marginal productivity of labor. The model delivers a theory of steady–state wage dispersion driven by heterogenous worker abilities and firm productivities, as well as by matching frictions. The structural model is estimated using matched employer and employee French panel data. The exogenous distributions of worker and firm heterogeneity components are nonparametrically estimated. We use this structural estimation to provide a decomposition of cross–employee wage variance. We find that the share of the cross–sectional wage variance that is explained by person effects varies across skill groups. Specifically, this share lies close to 40% for high–skilled white collars, and quickly decreases to 0% as the observed skill level decreases. The contribution of market imperfections to wage dispersion is typically around 50%.