How does a typically European bargaining system, with collective bargaining and national minimum wage, coexist with low unemployment and high wage flexibility? A unique data set on workers, firms, and collective bargaining contracts in Portugal is used to analyze the determinants of both the contractual wage and the wage cushion (difference between contractual and actual wages). The results indicate that the wage cushion stretches the returns to worker and firm attributes, whereas it shrinks the returns to union power. Therefore, firm‐specific arrangements partly offset collective bargaining, granting firms certain freedom when setting wages. Contractual wages reflect trade unions' egalitarian policy.

There is growing evidence that firm-specific pay premiums are an important source of wage inequality. These premiums will contribute to the gender wage gap if women are less likely to work at high-paying firms or if women negotiate (or are offered) worse wage bargains with their employers than men. Using longitudinal data on the hourly wages of Portuguese workers matched with income statement information for firms, we show that the wages of both men and women contain firm-specific premiums that are strongly correlated with simple measures of the potential bargaining surplus at each firm. We then show how the impact of these firm-specific pay differentials on the gender wage gap can be decomposed into a combination of sorting and bargaining effects. We find that women are less likely to work at firms that pay higher premiums to either gender, with sorting effects being most important for low- and middle-skilled workers. We also find that women receive only 90% of the firm-specific pay premiums earned by men. Importantly, we find the same gender gap in the responses of wages to changes in potential surplus over time. Taken together, the combination of sorting and bargaining effects explain about one-fifth of the cross-sectional gender wage gap in Portugal.

We synthesize two related literatures on firm-level drivers of wage inequality. Studies of rent sharing that use matched worker-firm data find elasticities of wages with respect to value added per worker in the range of 0.05–0.15. Studies of wage determination with worker and firm fixed effects typically find that firm-specific premiums explain 20% of overall wage variation. To interpret these findings, we develop a model of wage setting in which workers have idiosyncratic tastes for different workplaces. Simple versions of this model can rationalize standard fixed effects specifications and also match the typical rent-sharing elasticities in the literature.

Do more educated workers earn higher wages partly because they have access to high-paying firms and occupations? We rely on linked employer-employee data to combine the estimation of AKM models with the decomposition of the returns to schooling. We exploit exogenous variation in education driven by changes in compulsory education. We show that education provides access to better-paying workplaces and occupations: 30 percent of the overall return to education operates through the workplace channel and 12 percent through the occupation channel. The remainder is associated exclusively with the individual. Match quality plays a modest role in the returns to education.