DETERMINATION OF THE FIRM-LEVEL WAGE RATE: THE ROLE OF EMPLOYER-EMPLOYEE SPECIFIC EFFECTS

This paper examines the role of employees and firm characteristics in determining the Malaysian economy’s pay structure. It utilises a uniquely matched firm-worker dataset from one common year (2006), which allows for a more in-depth analysis of worker- and firm-specific effects on the individual worker’s pay. Using this matched data, we are able to estimate the statistical firm effect, but since we only have data for one year, we cannot therefore disentangle aspects of this effect that are due to unobservable worker or firm heterogeneity. And so, we adapted the two-stage estimation strategy proposed by Abowd, Kramarz, and Morgalis (2000) in order to keep any potential simultaneity bias under control. The result indicates that observable worker characteristics and unobserved firm-effects are important elements of pay determination. However, firm-effects seem to explain the variability in pay determination more than observable worker characteristics. In addition, the relationship between pay components (average predicted pay and firm-effect) and firm performance (productivity and profitability) exhibits a positive tendency. This implies that higher paid workers, either because of worker characteristics or firm-effects, are being employed in firms that are more productive and profitable.