The determination of wages of newly hired employees: Survey evidence on internal versus external factors

This paper reports findings on the relative importance of internal versus external factors in the setting of wages of newly hired workers. The evidence, from a rich firm-level survey on wage and price-setting procedures in 15 European Union countries, suggests that external labour market conditions are less important than internal pay structures in determining hiring pay, with internal pay structures binding even more often when there is labour market slack. When explaining their choice firms allude to fairness considerations and the need to prevent a potential negative impact on effort. Cross-country differences are found to depend on institutional factors: countries in which collective agreements are more prevalent and collective agreement coverage is higher report more often internal pay structures as the main determinant of hiring pay. Within-country differences are found to depend on firm and workforce characteristics: there is a strong association between the use of external factors in hiring pay, on the one hand, and skills (positive) and tenure (negative) on the other.

► Internal pay structures are more important than external conditions for hiring pay.
► This is due to fairness and the attempt to avoid a negative impact on effort.
► Firm differences depend on collective agreement coverage, skills and tenure.