Does employee pay raise indicate more persistent earnings?

Abstract

This study investigates the informativeness of an increase in employee wages with respect to earnings persistence. Building on wage rigidity theory, this study finds that the reported earnings of firms that increase employee pay are more persistent than those of firms that do not, consistent with the hypothesis that a commitment to rank-and-file employees conveys information about firms earnings quality. Also, cross-sectional tests show that this relation is more pronounced for firms with strong labor unions and firms that require higher labor skill, as employees of those firms have greater negotiation power in setting wages and therefore an increase in wages in those firms represents more of a commitment that is harder to decrease in the future. In sum, these results suggest that wage increases to rank-and-file employees are indicative of better earnings quality, in terms of earnings persistence.