J30 | Macro Paper Warehouse

Bargaining and Inequality in the Labor Market

Mon, 01 Jan 0001 00:00:00 +0000

Layer 1 — Overview

Research Question. How prevalent is individual wage bargaining in the labor market, what determines firms’ bargaining strategies, how do bargaining encounters unfold for workers, and does heterogeneity in bargaining behavior translate into wage inequality—including the gender wage gap?

Data and Setting. The paper develops and validates novel linked survey data for Germany. A firm survey was fielded by the ifo Institute to senior HR professionals and managers in two waves (September 2021 and January 2022), yielding 772 complete responses across all major sectors and regions. These responses were linked—with consent obtained from 72% of firms—to German Social Security records (the Integrated Employment Biographies, IEB) covering 416,821 full-time employees at matched firms in 2020, and to Orbis balance sheet data for firm productivity proxies. A separate worker survey was fielded by the IAB to 135,000 full-time German workers, with 9,756 completing it; nearly 10,000 responses were used for analysis, with 7,079 workers employed at surveyed firms. The worker survey elicited detailed bargaining histories for workers who had received an outside offer in the prior six months, bargaining at the start of current employment (for workers with tenure of three years or less), and responses to a hypothetical salary expectation scenario.

Definition of Individual Bargaining. The authors define a firm as having a “bargaining strategy” if it differentiates pay between workers in the same position it perceives to have similar productivity—encompassing both variation in initial offers (which may reflect firms using information on workers’ salary expectations) and back-and-forth negotiation. Elicitation distinguishes four employee groups (recent labor market entrants, experienced non-managers, managers, and bottleneck-occupation workers) and two contexts (new external hires and incumbent workers who receive an outside offer).

Prevalence of Bargaining. Approximately 50% of surveyed firms are willing to differentiate base wages for recent labor market entrants, more than 80% for experienced non-managers and managers, and nearly all for workers in bottleneck occupations they are struggling to fill. For incumbent workers facing outside offers, 57% of firms would increase pay for recent entrants, and more than 80% for experienced incumbents, managers, and bottleneck workers. In total, 80% of workers in the sample are in positions where individual bargaining is possible.

Magnitude of Wage Differentiation. For new external hires, the typical firm expects a gap between the highest and lowest offers of 3% for recent entrants, 5% for experienced non-managers, and 10% for managers (conditional on a gap: 6%, 10%, and 12% respectively). For incumbent workers responding to outside offers, the typical firm will adjust pay by 3% for recent entrants, 6% for experienced non-managers, and 10% for managers (conditional on responding: 6%, 7%, and 14% respectively). Forty-four percent of firms report that variation in initial offers is at least as important as back-and-forth negotiation in determining workers’ final pay.

Predictors of Firm Bargaining Strategies. Contrary to models predicting more productive firms are more likely to bargain (Doniger 2015; Postel-Vinay and Robin 2004; Flinn and Mullins 2021), firms that bargain are not more productive—as proxied by firm age, size, or assets per employee—nor do they pay higher mean wages. A variance decomposition shows that employee-group dummies alone explain 33% of variation in bargaining strategies for new hires, comparable to more than 500 firm dummies. Labor market factors—particularly whether a position is hard to fill—are systematically associated with bargaining willingness. Collective bargaining agreement (CBA) coverage and East German location are negatively correlated with bargaining flexibility.

How Bargaining Unfolds. In 57% of worker-firm interactions, the worker provides salary expectations before the firm makes its initial offer; 29% of firms require this information. About one-third of applicants ask for more after the initial offer, requesting on average a 3% increase; conditional on asking, about half of firms raise the offer, but fewer than one-third match what was requested, with the typical worker improving the offer by 1.5%. The majority of outside offers are rejected: only 9% of workers who received an outside offer in the prior six months chose to move to a new firm. Of the 91% who remained at their incumbent firm, 13% successfully renegotiated their pay. Back-and-forth dynamics—where offers are accepted or rejected only after multiple rounds—are consistent with models of two-sided incomplete information.

Worker Heterogeneity and Wage Inequality. Workers with better self-assessed outside options are 9 percentage points more likely to ask for an increase after the initial offer and 7 percentage points more likely to successfully negotiate a raise, relative to same-occupation coworkers with worse outside options. Women are 6 percentage points less likely to successfully negotiate their pay upward and show lower salary expectation provision rates, including in a hypothetical scenario in which pay range information is equalized. These gender differences in bargaining are not explained by women negotiating more over non-wage amenities; controlling for outside options and risk tolerance shrinks the female coefficient by at most 15%. Among surveyed workers, after controlling for occupation-establishment fixed effects, there is no gender wage gap at firms that do not bargain, but a 4–5 percentage point gender wage gap at firms that do bargain. Across specifications, firms that engage in individual bargaining have a 3 percentage point higher gender wage gap. A simple decomposition suggests that at surveyed firms, 44% of the residual gender pay gap can be attributed to bargaining. For workers at bargaining firms, a 10 percentage point higher pay premium at the prior firm is associated with 0.5 percent higher pay at the current firm, conditional on occupation-establishment fixed effects; this relationship is statistically insignificant for workers at non-bargaining firms.

Scope Conditions. Results apply to full-time private-sector workers in Germany between ages 25 and 50, with the firm sample over-representing medium and large firms (median size 50–249 employees). CBA coverage in the sample (41%) reflects Germany’s institutional context where firms retain the right to pay above CBA floors. Results are robust to re-weighting to match the overall distribution of German firm size and sector.

Layer 2 — Q&A

Q1. How do the authors define “individual bargaining” and why is this definition broader than standard labor economics usage? The authors define a firm as having a bargaining strategy if it differentiates pay between workers in the same position it perceives to have similar productivity, covering both tailoring of initial offers and back-and-forth negotiation. Standard labor economics definitions typically condition on wages being set ex post once outside options are revealed, and focus on back-and-forth negotiation alone. The authors’ definition is most analogous to standard definitions of price discrimination. Empirically, the vast majority of firms that differentiate initial offers (93%) are also willing to engage in back-and-forth negotiation.

Q2. How was the firm survey designed to elicit bargaining strategies reliably, and what is the “protocol question”? The protocol question asked: “How much more could a person maximally receive compared to the fixed compensation you would have offered based on the person’s qualification/fit for the position alone?” with options ranging from “0%/no adjustments possible” to “more than 40%.” Wording was developed through over 100 conversations with HR professionals; “qualifications and fit” was the phrase most closely aligned with HR professionals’ concept of productivity. The survey was fielded by the ifo Institute—an organization with decades of experience surveying this population—with a 51% response rate, 83% completion rate, and median response time of 11 minutes.

Q3. What validation exercises support the reliability of the elicited firm bargaining measures? Four exercises are reported. First, intra-respondent reliability: the cross-tabulations between the protocol and incidence questions show most mass on or below the diagonal (incidence-implied spread no greater than the protocol-implied flexibility). Second, inter-respondent reliability: among 37 firms with multiple respondents, there is significant overlap in independently provided answers. Third, external validity using publicly available data: for 90% of firms reporting no CBA, no CBA evidence is found; for 99% reporting no pay information in job ads, none is found in online postings; for 82% reporting no salary expectation elicitation, no evidence of it appears in online application forms. Fourth, the elicited firm strategies are highly correlated with the matching workers’ survey responses—e.g., workers at firms stating they elicit salary expectations are significantly more likely to report having provided these expectations.

Q4. Is firm productivity associated with whether a firm engages in individual bargaining? No. Firms that bargain and those that do not are similar with respect to firm size, firm age, and total assets per employee, and they also do not differ significantly in their AKM wage premium. These findings are inconsistent with theoretical models predicting that more productive firms are more likely to set pay via bargaining (Doniger 2015; Postel-Vinay and Robin 2004; Flinn and Mullins 2021). The result holds for both binary and continuous measures of bargaining, and is not overturned by machine learning prediction attempts.

Q5. What firm characteristics other than productivity predict bargaining strategies? CBA coverage is negatively correlated with wage flexibility—CBA-covered firms report less flexibility even for managers who are typically exempt from CBAs and for groups not covered by CBAs, suggesting institutional norms or culture matter. Firms headquartered in East Germany are less likely to bargain with workers in all groups. Publicly traded firms (stock-based corporations) are more likely to set wages flexibly. These correlations are consistent with the view that managerial style and firm culture (rather than productivity) shape wage-setting strategies.

Q6. What does the variance decomposition say about the relative importance of firm versus market factors in predicting bargaining strategies? Employee-group dummies alone explain 33% of the variation in bargaining strategies for new hires. After adjusting for the number of fixed effects used, four employee-group dummies explain as much variation as more than 500 firm dummies. Adding firm characteristics or coarse industry dummies does not significantly improve the adjusted R-squared relative to a model containing only group dummies. This supports models emphasizing market-level factors (worker replaceability, labor market tightness) over firm-level factors.

Q7. How common is it for workers to provide salary expectations before receiving an initial offer, and what do firms do with this information? In 57% of worker-firm interactions, the worker provides salary expectations before the firm makes its initial offer. Twenty-nine percent of firms require this information; most ask for it. Forty-four percent of firms report that variation in initial offers is at least as important as subsequent back-and-forth negotiations in determining workers’ final pay. HR professionals and prior research indicate firms interpret variation in stated expectations as reflecting outside options rather than productivity.

Q8. What fraction of outside offers are rejected, and what happens when workers stay at the incumbent firm? Only 9% of workers who received one or more outside offers in the prior six months chose to move to a new firm. Of the 91% who remained at the incumbent firm, 13% successfully renegotiated their pay at the incumbent. A follow-up survey fielded in spring 2024 corroborates this finding, showing approximately 80% of workers who received an outside offer remained at the incumbent firm; even recoding all job-to-job transitions as accepted offers implies no more than 26% of offers lead to a transition.

Q9. What do the back-and-forth dynamics imply for appropriate theoretical models of wage bargaining? That many offers are accepted or rejected only after multiple rounds of negotiation is difficult to rationalize with models assuming either firms or workers have perfect information, which typically predict immediate acceptance or rejection. The patterns are consistent with models of two-sided incomplete information (Perry 1986; Chatterjee and Samuelson 1983). Sixty-nine percent of HR professionals in the survey report that decision-makers at their firm only have market-level information on wages, not specific information on what competitors pay.

Q10. How do outside options predict worker bargaining behavior and outcomes, controlling for occupation-establishment fixed effects? Workers who rated it “easy” or “very easy” to obtain a better outside offer are 9 percentage points more likely to ask for an increase after the initial offer and 7 percentage points more likely to successfully negotiate a raise relative to same-occupation-establishment coworkers who rated it “difficult” or “very difficult.” The same pattern persists during the employment spell: workers with better outside options are 9 percentage points more likely to initiate and 8 percentage points more likely to succeed in renegotiation. These workers are not more likely to receive raises without asking.

Q11. How does risk tolerance predict bargaining, and how does it compare to outside options? Workers with greater risk tolerance (those rating themselves 7 or above on a 10-point scale) are more likely to engage in wage negotiations and more likely to succeed both at the start of and during employment spells. Gaps in successful negotiations are somewhat larger than gaps in attempted negotiations, suggesting risk-tolerant workers also negotiate more effectively. However, outside options explain more of the between-worker variation in bargaining behavior than risk tolerance does.

Q12. What are the gender differences in bargaining behavior, and can they be explained by differences in outside options or risk tolerance? Women are less likely to engage in back-and-forth negotiations and are 6 percentage points less likely to successfully negotiate pay upward during an employment spell. Women are also less likely to provide salary expectations and provide lower expectations as a fraction of their current salary in the hypothetical scenario, including when the salary range is provided—women are 6 percentage points less likely to provide expectations above the top of the stated range. Controlling for outside options and risk tolerance shrinks the female coefficient by at most 15%. There is no evidence that women substitute toward negotiating for non-wage amenities. The pattern is most consistent with women finding negotiation uncomfortable, not with a belief that it will not pay off or fear of backlash.

Q13. What is the estimated gender wage gap attributable to individual bargaining? Among surveyed workers, after controlling for occupation-establishment fixed effects, there is no gender wage gap at firms without individual bargaining (coefficient closes to zero), while a 4–5 percentage point gender wage gap persists at firms with individual bargaining. This difference is robust across measures of pay (total daily pay, base pay, pay conditioning on hours worked), alternative fixed effect specifications, and to including non-surveyed workers at surveyed firms. A simple decomposition suggests 44% of the residual gender pay gap at surveyed firms can be attributed to bargaining. Across the interaction specifications, bargaining firms have a 3 percentage point higher gender wage gap and—in one key specification—a 6 percentage point difference between the gender gaps at bargaining and non-bargaining firms.

Q14. How does a worker’s prior firm wage premium affect current wages, and does bargaining status matter? In a regression of log current wages on the AKM wage premium of the prior firm (conditional on occupation-establishment fixed effects), a 10 percentage point higher pay premium at the prior firm is associated with 0.5 percent higher pay at the new firm for workers at bargaining firms. For workers whose pay is not set via individual bargaining, the relationship between the prior firm’s pay premium and current pay is statistically insignificant. The result is consistent with the idea that during negotiations with a new firm, workers use their prior firm’s pay policy as an outside option.

Q15. How do AKM person effects relate to bargaining behavior? Higher-person-effect individuals are more likely to have provided salary expectations when applying to their current firm and ask for a larger fraction of their current salary in the hypothetical scenario (conditional on their wage). These differences persist when controlling for occupation-establishment fixed effects and age and experience. Higher-person-effect workers are not more likely to receive raises without asking. These results are inconsistent with AKM person effects reflecting only productivity differences and instead suggest that fixed differences in individual bargaining behavior contribute to the variance in person effects—which Card, Heining, and Kline (2013) estimated explains a large share (40%) of the growth in German wage inequality.

Q16. Are the bargaining patterns found at surveyed firms representative of bargaining more broadly? Two robustness exercises support broader representativeness. First, similar bargaining dynamics are found when including a random sample of German workers employed at non-surveyed firms. Second, re-weighting the sample to match the overall distribution of firm size and sector in Germany yields similar results. Because medium and large firms are over-represented in the firm sample, and because small firms hire infrequently and are less likely to have formal bargaining strategies, the true prevalence of individual bargaining among all German firms may be somewhat lower.

Key Concepts

Individual Bargaining Strategy (firm-level). A firm has an individual bargaining strategy if it differentiates pay between workers in the same position that it perceives to have similar productivity. This definition encompasses both tailoring of initial offers (based on, e.g., workers’ stated salary expectations) and back-and-forth negotiation. It is analogous to price discrimination rather than to the standard labor economics distinction between wage posting and Nash bargaining.

Protocol Question. The main survey measure of firm bargaining strategies: firms are asked the maximum percentage by which pay could be increased for a new hire above the fixed compensation the firm would have offered based on qualifications and fit alone, with response bins from “0%/no adjustments” to “more than 40%.” A zero response is used to classify a firm as not bargaining.

Incidence Question. A supplementary survey measure eliciting the expected spread (between highest and lowest offers) that the firm would make to ten candidates with identical qualifications and fit but differing stated salary expectations and competing offers. Used to validate the protocol question and to quantify the importance of initial-offer differentiation relative to back-and-forth negotiation.

Bottleneck Occupation. A firm-defined category of workers in positions that are particularly difficult to fill, drawing on an official German Federal Employment Agency designation. In the paper, bargaining willingness is systematically higher for workers in these positions than for other workers at the same firm, providing evidence that labor market tightness drives bargaining strategies.

Outside Offer Renegotiation. Wage renegotiation at the incumbent firm triggered by a worker receiving an outside offer, without a change in job tasks. The paper documents this is empirically more common than actual job-to-job transitions: of workers receiving outside offers, 91% remain at the incumbent firm, and 13% of those who remain successfully renegotiate their pay.

AKM Person Effect. A worker fixed effect estimated from a two-way fixed effects regression of log wages on worker and firm fixed effects (following Abowd, Kramarz, and Margolis 1999). In this paper, AKM person effects are taken from Bellmann et al. (2020), estimated over 2010–2017 German population data. The paper provides evidence that these effects capture, in part, fixed differences in individual bargaining behavior rather than solely differences in productivity.

AKM Firm Effect (Wage Premium). The firm fixed effect from the same two-way fixed effects regression, representing the pay premium a firm pays relative to what would be expected given its workforce composition. The paper uses the prior firm’s AKM effect as a measure of a worker’s outside option quality when testing whether prior-firm pay policy influences current pay under individual bargaining.

Salary Expectations (Gehaltsvorstellungen). The wage figure a worker provides to a prospective employer, typically before the firm’s initial offer. Legally, German firms (like most US states) cannot ask for salary history but can ask for salary expectations. In the paper, 57% of worker-firm interactions begin with the worker providing expectations; firms report using these to tailor initial offers, interpreting variation in stated expectations as reflecting outside options rather than productivity.

The Effects of Mandatory Profit-Sharing on Workers and Firms

Mon, 01 Jan 0001 00:00:00 +0000

This paper studies the causal effects of mandatory profit-sharing on workers and firms using a quasi-experimental design arising from a 1990 French reform that lowered the eligibility threshold for mandatory profit-sharing from 100 to 50 employees. The institutional setting is the French RSP (Réserve Spéciale de Participation), a profit-sharing scheme in place since 1967 that requires firms above the threshold to distribute a fraction of their excess profits — defined as net income above 5% of book equity — to employees according to a formula scaled by the firm’s labor share. For the median firm, this amounts to roughly 10.5% of pre-tax income transferred to workers.

The authors employ two primary empirical strategies. First, a bunching analysis exploits the pre-reform distribution of firm employment around the 100-employee threshold as a revealed-preference test of whether firms perceive profit-sharing as a net cost. Second, a difference-in-differences design compares treated firms (55–85 employees in 1989–1990, who become newly subject to the regulation after 1991) against two control groups: small firms (35–45 employees, likely never subject) and large firms (120–300 employees, already subject). Data come from the universe of French corporate tax files (FICAS) and a linked employer-employee panel (DADS) covering approximately 4% of private-sector workers, spanning 1985–1997.

The bunching analysis documents a 22.3% excess density in the 95–99 employee bin before the reform, which disappears after 1991. Three tests — comparing wage bills per employee across the threshold, cross-checking with DADS employment records, and examining profitability patterns — collectively support the conclusion that bunching reflects genuine employment reductions rather than under-reporting. The implied employment loss is approximately 1.67% of total employment among affected firms.

The difference-in-differences results yield the following firm-level findings: (a) the total compensation share (wages plus profit-sharing divided by value added) rises by 1.8 percentage points for firms with positive excess profits; (b) 77% of this increase comes at the expense of firm owners — the profit share falls by 1.37 percentage points; (c) the remainder is borne by the government through a reduction in the corporate income tax share; (d) the wage share (base wages only) is unaffected, indicating that owners do not reduce wages to offset the cost of profit-sharing; (e) investment and total factor productivity show no statistically significant change — effects on productivity are bounded below ±1% for several TFP measures; and (f) the capital-labor ratio shows a small, mostly insignificant negative effect, consistent with a model-implied increase in the cost of capital of only 0.43 percentage points.

Worker-level analysis using the linked employer-employee data confirms that average total compensation rises by approximately 3.5% for workers in treated firms, with no decline in base wages. Critically, this average conceals distributional heterogeneity across the skill spectrum. For low- and medium-skill workers (blue-collar workers, clerks, supervisors, skilled technicians), total compensation rises while base wages are unchanged — consistent with wage rigidity binding for these groups. For high-skill workers (managers, engineers, executives), base wages fall by enough to leave total compensation unchanged, consistent with more flexible wages at the upper end of the skill distribution. This pattern implies that mandatory profit-sharing is a progressive policy within firms, redistributing excess profits predominantly to lower-skill workers.

The paper concludes that France’s mandatory profit-sharing scheme, as implemented, functions as a non-distortive redistributive tool: it transfers excess profits from shareholders to lower-skill workers without generating measurable productivity losses or large investment distortions. The fiscal cost is non-trivial: each dollar transferred to workers costs approximately 20 cents in foregone corporate income tax. The scheme also has an inherent inequality in its redistribution since it exclusively benefits workers in profitable firms, and firms’ excess profits are highly persistent.

Q: What is the French RSP and how does the formula work? A: The RSP (Réserve Spéciale de Participation) is a mandatory profit-sharing fund established by executive order in 1967. The formula is RSP = 0.5 × (wage bill / value added) × max(net income − 5% × book equity, 0). The 5% deduction represents lawmakers’ view of fair compensation to shareholders; any excess is split between shareholders and workers, with the split scaled by the firm’s labor share. For the median firm in the sample — ROE of 12%, labor share of 0.52, corporate tax rate of 37% — the formula yields roughly 9.5% of pre-tax income, and in post-1991 data the realized average is 10.5% of pre-tax income for firms with positive excess profits.

Q: Why can’t a standard regression discontinuity be used at the 100-employee threshold? A: Because firms strategically control their position relative to the threshold — the bunching analysis itself demonstrates this. When firms sort non-randomly around the cutoff, the local randomization assumption underlying RD is violated. The authors instead use a difference-in-differences design exploiting the time variation introduced by the 1990 reform.

Q: How large is the pre-reform bunching and what does it imply? A: The distribution of employment shows 22.3% excess density in the 95–99 employee bin relative to the post-reform counterfactual distribution. Interpreting this as real employment reduction (supported by three empirical tests), the implied employment loss is approximately 1.67% of total employment among firms in the 85–120 employee range. Dynamic bunching analysis shows this is persistent rather than temporary — the 100-employee threshold significantly constrained three-year employment growth for firms in the 85–99 range in the pre-reform period.

Q: How do the authors establish that bunching is real rather than under-reporting of employment? A: Three tests are conducted. First, wage bills per employee show no discontinuity around the 100-employee threshold in either period, ruling out systematic under-reporting of headcount while truthfully reporting wages. Second, employment from DADS payroll records — harder to manipulate — shows only a statistically insignificant gap of roughly 0.5 employees relative to tax-file employment just below the threshold, far too small to shift firms across the 100-employee bin. Third, profitability and value added per employee are significantly higher just below the threshold, consistent with more profitable firms having stronger incentives to bunch through genuine employment reductions.

Q: What is the main identification strategy for the firm-level analysis? A: A difference-in-differences design where treated firms have 55–85 employees in both 1989 and 1990 (newly subject to the mandate after 1991), compared to small control firms with 35–45 employees (likely never subject) and large control firms with 120–300 employees (likely always subject). Specifications include firm fixed effects and county-by-year and industry-by-year fixed effects. Parallel pre-trends are confirmed graphically and in event-study regressions. The design is intent-to-treat: by 1997, 26.7% of treated firms had shrunk below 50 employees and did not actually pay profit-sharing. LATE estimates are obtained via 2SLS.

Q: What are the main firm-level findings on compensation and profit shares? A: For treated firms with positive excess profits, the total compensation share rises by 1.8 percentage points. The wage share (base wages only, excluding profit-sharing) is precisely estimated at zero — owners do not reduce wages. The profit share falls by 1.37 percentage points, accounting for 77% of the increase in total compensation. The remaining approximately 23% is borne by the tax authority through a reduction in the corporate income tax share, since profit-sharing reduces the corporate income tax base. These findings are robust to balanced vs. unbalanced samples and to alternative control group definitions.

Q: Does mandatory profit-sharing raise or lower firm productivity? A: Across five different TFP estimators (Olley-Pakes, Olley-Pakes with Ackerberg-Caves-Frazer correction, Wooldridge, Levinsohn-Petrin, and Ackerberg-Caves-Frazer), the effect of mandatory profit-sharing on productivity is a precisely estimated zero. For several measures, effects larger than ±1% in magnitude can be rejected. Softer measures of effort — sick leave rates and the probability of working extra hours — also show no significant change. This null finding contrasts with the literature on voluntary profit-sharing adoption, which typically finds 3–5% productivity gains, likely reflecting selection bias in that literature.

Q: Does mandatory profit-sharing distort investment? A: The effect on investment is small and mostly statistically insignificant. The theoretical model shows why: the profit-sharing formula is based on excess profits (net income minus 5% of book equity), not total profits. When the firm’s actual cost of equity approximately equals the regulatory 5% benchmark, the distortion to the cost of capital is zero. The calibrated distortion to the user cost of capital is only 0.43 percentage points — approximately 1.9% of the standard user cost — implying an investment ratio reduction of about 0.84 percentage points using estimated elasticities from Chodorow-Reich et al. (2024). Empirically, capital-labor ratios show a small, largely insignificant negative effect.

Q: How does profit-sharing incidence differ across the skill distribution? A: The worker-level DADS analysis reveals that the average 3.5% increase in total compensation masks sharp heterogeneity. For low- and medium-skill workers (blue-collar workers, clerks, supervisors, skilled technicians), total compensation rises while base wages are unchanged. For high-skill workers (managers, engineers, executives), base wages decline sufficiently to leave their total compensation unchanged. The authors interpret this pattern as consistent with wage rigidity being more binding for lower-skill workers — due to the federal minimum wage and collective agreements — than for managers whose pay is more flexibly set.

Q: Why does profit-sharing not affect base wages for low-skill workers? A: Two candidate explanations are considered. The risk channel — that profit-sharing is risky and thus less valuable to risk-averse workers, who demand wage compensation — is rejected empirically because profit-sharing only marginally increases the variability of workers’ total earnings. The wage rigidity channel is supported: France’s binding federal minimum wage and widespread collective agreements constrain downward adjustment in base wages for lower-skill workers, so firms cannot pass through profit-sharing costs as lower wages for this group.

Q: What is the fiscal cost of the profit-sharing scheme? A: Each dollar transferred to workers through mandatory profit-sharing costs approximately 20 cents in reduced corporate income tax receipts, since profit-sharing payments are deductible from taxable income. The paper notes this is a partial fiscal evaluation; a full assessment would also require analyzing personal income tax implications, which are left for future work.

Q: How does this scheme compare to a corporate income tax as a redistributive tool? A: Both instruments reduce firm profits and can benefit workers, but differ in three key respects. First, the tax base differs: profit-sharing targets excess profits above 5% of book equity whereas the corporate income tax applies to all corporate earnings, generating different distortions to investment. Second, profit-sharing goes directly to workers in the same firm, whereas corporate tax revenues are redistributed through general government spending — making the incidence more direct and more closely monitored by workers. Third, workers have stronger incentives to monitor firm compliance with profit-sharing (each euro of diverted excess profit reduces workers’ collective income by roughly 10–15 cents) than with corporate taxes.

Q: How does this paper compare to findings on mandatory profit-sharing in Peru? A: Tolentino (2022) studies a mandatory profit-sharing scheme in Peru exploiting a 20-employee eligibility threshold and finds larger distortions — reductions in both investment and productivity. The authors attribute this difference to two features: the Peruvian scheme applies to the entirety of post-tax profits rather than excess profits above an equity deduction, creating a broader and more distortionary base; and there is pre-existing bunching at the Peruvian threshold even before the scheme was introduced, suggesting confounding pre-existing regulations.

Q: What are the scope conditions on the external validity of the findings? A: The findings apply specifically to mandatory profit-sharing under the French RSP formula — which exempts a 5% equity return from the profit-sharing base, limiting distortions — during 1985–1997, for firms in the 55–300 employee range. The null productivity effect may not generalize to voluntary schemes, where selection on anticipated gains likely produces positive correlations. The redistributive finding (benefiting lower-skill workers) is specific to a context with binding minimum wages and collective agreements that constrain wage adjustment for that group. The fiscal cost calculation also excludes personal income tax effects.

Excess profits: Defined in the paper as net income minus 5% of book equity — the amount above what lawmakers considered fair compensation to shareholders. Only excess profits (not total profits) are subject to the mandatory profit-sharing formula.

RSP formula (Réserve Spéciale de Participation): The statutory formula RSP = 0.5 × (wage bill / value added) × max(net income − 5% × book equity, 0), scaled by the firm’s labor share to reflect labor’s contribution to production. Unchanged since 1967.

Total compensation share: The ratio of (wage bill plus profit-sharing) to value added — the paper’s primary measure of workers’ overall claim on firm output, as distinct from the wage share (wage bill alone divided by value added).

Wage incidence parameter (λ): The fraction of profit-sharing that firms pass through to workers as lower base wages. λ = 1 means full incidence (workers’ total compensation unchanged); λ = 0 means no incidence (workers fully benefit). The paper’s empirical findings are consistent with λ ≈ 0 for low-skill workers and λ ≈ 1 for high-skill workers.

Bunching: The empirical phenomenon whereby firms cluster employment just below the 100-employee regulatory threshold to avoid mandatory profit-sharing. The paper uses the pre- vs. post-reform shift in the employment distribution as a revealed-preference test of whether firms perceive the scheme as a net cost.

Intent-to-treat (ITT) design: The empirical design comparing firms that were in the newly eligible size range (55–85 employees) just before the 1990 reform against firms that were either always or never eligible, regardless of whether treated firms actually ended up paying profit-sharing post-reform. LATE estimates are obtained via 2SLS to recover effects on actual compliers.

Distortion to user cost of capital: The additional cost of capital induced by profit-sharing, equal to ϕ × γ(1−λ) / [1 − γ(1−τ)] × (re − ρ), where ρ = 5% is the regulatory equity benchmark. When the firm’s actual cost of equity equals the 5% benchmark, this distortion is zero — a feature that distinguishes the French scheme from a standard corporate income tax.

The price of intelligence: How should socially-minded firms price and deploy AI?

Mon, 01 Jan 0001 00:00:00 +0000

Leading AI firms such as OpenAI and Anthropic publicly claim dual mandates of profit and social welfare, raising the question of whether—and how—a social mandate should change their pricing and deployment decisions. This paper provides a framework to answer this question, deriving a Modified Lerner Rule for socially minded AI firms that extends the standard profit-maximizing Lerner Rule to incorporate incentives for aggregate efficiency, distributional concerns, and labor market stability. Using U.S. data on 525 detailed occupations, the paper evaluates optimal pricing and deployment paths for an AI capable of replacing human labor in each job at 50% of the cost. The main finding is that a welfarist firm (one that values profits and social welfare) should price closer to marginal cost because, for the jobs considered, efficiency gains outweigh distributional concerns—AI does not primarily displace low-income workers. A conservative firm focused on labor market stability should price above the profit-maximizing level in the short run, but not in the long run. The paper concludes that the most pro-social course of action for AI firms with market power is to refrain from exercising that power, and that proposals to tax AI to protect labor markets miss the counteracting role of market power.

Summary of a forthcoming paper, AI-assisted and human-reviewed. See the linked original for the authoritative claims and full conditions.

In depth

Q1. What is the Modified Lerner Rule and what motives does it capture?

The Modified Lerner Rule states (P − MC)/P = M/ε, where ε is the demand elasticity and M is a modifier that summarizes the motives of the socially minded firm; M = 1 corresponds to the standard profit-maximizing Lerner Rule. The modifier M reflects four distinct considerations: (1) profit motives push M toward 1; (2) aggregate efficiency considerations push M toward 0 (marginal-cost pricing, which maximizes the “size of the pie”); (3) distributional concerns (who benefits from AI) can be positive or negative depending on whether AI substitutes for high- or low-income workers; and (4) the incentive to minimize labor market disruptions pushes M above 1 in the short run, because the cost of labor disruption is higher while workers are still adjusting, but not in the long run. The formula is derived in a general equilibrium model where the AI firm has a monopoly over an AI capable of replicating human skills.

Q2. What does the welfarist case imply for pricing?

A firm that values both profits and aggregate social welfare should price closer to marginal cost than the profit-maximizing firm, because for all 525 occupations considered, the aggregate efficiency gains from AI adoption outweigh the distributional costs. This finding reflects the structure of AI’s labor market effects: since AI does not primarily displace low-income workers in the US occupational data used, distributional concerns do not push toward restricting AI access. The welfarist firm therefore faces a dominant efficiency motive to expand access by pricing down toward marginal cost, accepting lower profits in exchange for greater welfare gains from AI adoption.

Q3. What does the conservative case imply?

A firm focused solely on labor market stability should price above the profit-maximizing level in the short run, because restricting AI deployment reduces the speed of worker displacement; but this above-profit-maximizing pricing is optimal only temporarily, and converges toward profit-maximizing pricing in the long run as workers adjust. The intuition is that the cost of disrupting the labor market is highest when workers have not yet adjusted—their human capital is not yet redeployed—so a conservative firm acts as a gradual deployer. This conservative pricing is distinct from the welfarist case: the conservative motive restricts access more than a welfarist mandate, since it is willing to sacrifice efficiency to slow disruption.

Q4. Why does the paper argue against taxing AI?

The paper argues that proposals to tax AI firms to protect workers from displacement overlook the fact that AI firms may already exercise significant market power, which protects workers by restricting AI supply below the efficient level. Adding a tax on top of an already-restricted supply would harm consumers (who face high AI prices and limited access) without providing meaningful additional protection for workers (since output is already suppressed by market power). The paper’s analysis implies that the first-order social priority is to have AI firms refrain from exercising their market power—by pricing closer to marginal cost—rather than further restricting supply through taxation.

Key concepts

Modified Lerner Rule : (P − MC)/P = M/ε, where M captures a socially minded firm’s weighting of profit, aggregate efficiency, distributional, and stability motives; the paper’s key pricing formula, derived from a GE model with a monopoly AI firm.

welfarist vs. conservative firm : two polar cases: the welfarist firm maximizes a weighted sum of profits and aggregate welfare (implying near-marginal-cost pricing); the conservative firm prioritizes labor market stability (implying above-profit-maximizing pricing in the short run to slow displacement).

labor disruption cost : the welfare cost to workers of being displaced by AI, which is higher in the short run when workers must reallocate across jobs or sectors and lower in the long run after adjustment; the paper’s formal treatment of this cost motivates the conservative firm’s gradual deployment strategy.