Wage differences between internal and external candidates

Purpose – The purpose of this paper is to investigate three hypotheses for the existence of a wage premium between incumbents and employees who are hired from other employers in the external labour market. Design/methodology/approach – The paper presents estimates of wage equations for a sample of externally hired workers and internally promoted employees. It uses an employer-employee matched data set of Dutch firms from all economic sectors (1998). It controls for various observed characteristics of the firm, the worker and the job. Findings – The estimates reject the hypothesis that firms rely more on observable characteristics for wage formation of external candidates. Nor do the estimates favor the prediction that there is a wage premium due to the option value of risky employees. Finally, employees who are recruited internally have on average a 15 percent higher wage (net of tenure) than comparable employees who are hired from other employers. Research limitations/implications – It was found that there was a limited possibility of identifying risky employees. Practical implications – Firms do not reward risky employees; the incumbents seem to be of better quality than the external hirees. Originality/value – Here the focus is on hirees who were previously employed elsewhere. Usually, a broader definition of external hiring is used.