The Employment Consequences of Seniority Wages

In an international comparison, German workers have a long seniority and face larger problems to find a new job when they are older – the relative unemployment rate of people older than 55 is clearly higher in comparison to the average unemployment rate than in any other OECD country. Both facts point at a potentially important impact of deferred compensation on the employee structure and hiring behaviour. Firms that defer compensation pay their older employees with long seniority higher wages than their productivity, in exchange of lower wages at the beginning of their careers. This provides them with an efficient mechanism to motivate and retain their employees. In this paper the deferred wage hypothesis is tested indirectly by looking at the employment structure and hiring consequences of high seniority wages. Our main assumption is that firms with deferred compensation have a relatively steep seniority-wage profile in comparison to their competitors. As a consequence, they can keep their employees longer and hire less older unemployed (because they are too expensive if they are paid according to the insiders with longer tenure but the same age). In order to calculate differences in seniority wages between establishments and their consequences on the employment structure and hiring behaviour, this paper combines two strains of the literature. The first strain separates seniority and job matching wage effects on the basis of individual data, but cannot look at employment consequences. The second strain explains the employment structure on the basis of establishment data, but cannot properly calculate seniority wages. This paper uses linked employer-employee data, aggregates individual seniority wages to the establishment level, and correlates them with the establishment employment structure. From the individual wage estimations that are performed according to the two most influential seniority wage estimation approaches, we learn that in an international comparison German firms pay relatively high seniority wages. In the estimations on the consequences of seniority wages, it finds according to the deferred compensation hypothesis that establishments with stronger seniority wages have a higher tenure but hire less older employees. These results are obtained by calculating all variables as deviations from sector means. These results are taken as evidence that at least some German establishments use deferred payments and hereby retain workers but lock out older employees.

Zwick, Thomas (2008), The Employment Consequences of Seniority Wages, ZEW Discussion Paper No. 08-039, Mannheim, published in: Industrial and Labor Relations Review.