Playing with the big boys

Everyone knows that big firms pay more: that’s why people want to work there. There are a few explanations as to why this might be the case. Maybe big firms make greater rents by exercising market power. maybe they can attract more skilled workers. Maybe there are economies of scale which make them more efficient and increase the productivity of their workers.

A recent study by John Gibson and Steve Stillman has a look at whether it’s attributable to higher skills:

We use the International Adult Literacy Survey, which gives richer skill measures than those typically available in labor market surveys, to measure the BFP in nine countries with and without controls for worker skill. The results show that the BFP is not as universal as is often suggested, but in countries where it exists controlling for skills does little to reduce the size of the BFP.

So, no, it’s not a skill thing. They do actually pay more for workers with the same skills. Gibson and Stillman point out that the policy response depends on what you think the cause is. If it’s market power causing it then maybe you want to rein in the big firms. if it’s increased productivity then maybe you want to let them run free and just watch the prices they charge a little more carefully.

I know a lot of lawyers so I’ve always associated big firms with big money, but even bigger hours worked. I did a quick Google search on ‘big firm hours worked’ and almost every hit on the first few pages was a legal one, so maybe that’s specific to the law profession. If anyone has a chart of firm size against hours worked I’d be interested to see it, though 🙂

  • Interesting thing about law firms is that at the lower levels you will get paid far worse at one of the big firms than a small firm. Becuase of the reputational effects and perhaps the promise of greater rewards if you ever climb high enough, my impression is that big law firms have market power in the labour market, and thus at the lower end pay significantly less.

    Back to your original question, and using law firms as specific example, workers are possibly better utilised at big law firms since they will be diversified across more business areas/partners bringing in work. This effect would probably be countered somewhat byu the greater job security a diversified firm offers thus meaning workers would be willing to accept a lower wage.

  • Robbie

    The existence of big firms suggests imperfect markets, which implies rents. If the conditions for perfect markets exist, we tend to get lots of buyers and sellers, rather than fewer larger firms.

    I agree we need to see more. I like the point about hours worked, this would be interesting. Many of my supposedly well paid friends don’t make such great coin on a per-hour basis.

    There’s also something around the type of work done, or the quality. Some entry level grad roles look very similar (esp. from the IALS point of view) to senior business analyst roles. In practise, these jobs are markedly different in terms of the value they add, but also the scarcity of the labour that can fill the role.

    Being a CEO or senior executive requires only the most basic technical skills: reading documents and talking to people. They are paid a lot because they see things that others don’t when they read documents, and are also able to hold converstations that other’s can’t.

  • You could perhaps work efficiency wages into your story somehow? That is, if wages encourage productivity, firms that can afford to might pay above market-clearing rates.

  • steve

    Yea I would note that bigger firms have market power. while they pay the senior staff considerably better, they take advantage of the junior staff because they rely on the firm for experience. I’m only speaking anecdotally but check all the big 4 accounting firms and all the larger law firms. smaller law firms and accounting firms pay grads better than the larger firms, but larger firms pay the partners and associates higher.

  • Rob

    What about financial vs. non-financial incentives? Perhaps working at a smaller firm affords more non-financial benefits to the employee than does working at a big firm (e.g. work autonomy, collegial atmosphere, etc.). Larger firms perhaps need to offer more financial incentives to their workers in order to make up for the lack of non-financial incentives that they can’t/don’t offer. At the small consulting firm I used to work at, there were a few consultants who said they would never work for a big firm again because they found the atmosphere ‘too corporate’.