This article investigates wage differentials for employees of different size firms utilizing an econometric methodology that allows the size of employer to be treated as endogenous in the context of discrete, ordered employer-size data. As a result we are able to estimate (i) employer-size wage gaps, which are corrected for selectivity bias, and (ii) the magnitude and direction of the selection bias. Decompositions of the resulting wage differentials are computed, with comparisons of the conditional (on sorting across employer size) and unconditional wage gaps.

This article formulates and estimates alternative equilibrium models of industrial wage determination and self-selection. In explaining industrial wage differentials, we find that it is important to account for heterogeneous sector-specific skills and self-selection decisions by agents concerning their sector of employment. The classical Roy model is rejected. So is an efficiency units model of the labor market. A revised Roy model that accounts for comparative advantage in the choice of industrial sectors and choice between market and nonmarket work is much more successful in explaining cross-section wage distributions and their evolution over time.