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.