How Does Firm Performance Affect Wages? Evidence from Idiosyncratic Export Shocks

In the canonical competitive labor market model, firms are wage-takers and idiosyncratic shocks to individual firms do not affect wages. However, when labor markets are frictional, wages may directly depend on firm-specific factors. We test how sensitive wages are to firm-level labor demand by estimating the incidence of idiosyncratic export demand shocks on the wages of incumbent workers in Portugal during the Great Recession (2008-2010). Using detailed export records, we construct measures of firm exposure to unanticipated shocks to the demands of different countries for specific products. The shocks predict changes in output and payroll at affected firms, but not at other similar firms. We combine the export demand measures with firm balance sheet data and matched longitudinal administrative employer-employee records to estimate the impact of idiosyncratic firm-level demand shocks on employee outcomes. We find that idiosyncratic shocks that decreased sales or value added by 10 percent caused wages to grow 1.5 percent less for incumbent workers who were employed by affected firms in 2007. Furthermore, we find that these pass-through effects are stronger in industries with higher durability of employment relationships and lower employee turnover rates. These results support a model in which barriers to replacing incumbent workers give rise to internal labor markets within the firm, exposing workers to their employersâ idiosyncratic conditions.