Valuing Labor Market Power: the Role of Productivity Advantages

Abstract

Consistent with the exercise of market power, firms with high labor productivity have low labor shares, high profitability, and high market valuations without high investment rates. I quantify the economic value that firms of different productivity levels derive from their labor market power by estimating the effect of unanticipated firm-level labor demand shocks on wages and employment at publicly listed U.S. firms. Productive firms face lower labor supply elasticities, and especially for skilled workers, who are disproportionately employed at more productive firms. Combining empirical estimates with a dynamic wage posting model in which firms face upward-sloping labor supply and adjustment costs in hiring, I estimate that firms in the top and bottom quartiles of labor productivity pay 62% and 94% of marginal product, respectively, despite the fact that adjustment costs temper the exercise of labor market power. Markdown differentials can explain three-fifths of the average spread in log labor shares between high- and low-labor productivity firms, and the evolution of these differentials can explain most of the change in the aggregate labor share in the 1991--2014 period. Holding constant equilibrium labor demand, I estimate that about a third of capital income for the typical firm stems from wage markdowns. Aggregate wage markdowns are worth two-fifths of total capital income.

Keywords: monopsony, market power, labor productivity, labor share, firm valuations

JEL Classification: J24, J42, E25