This Paper provides microfoundations for wage compression by modelling wage-setting in a world of heterogeneous workers and firms. Workers are differentiated by observable innate ability. A high-ability worker confers on a firm an externality, since their ability raises the average level of...

We develop a model of monopsonistic wage competition with heterogenous worker ability and intra-firm production complementarities. We use this to illustrate the conditions under which: (i) the divergence between wages and productivity is an equilibrium phenomena; and (ii) this divergence is...