A large number of studies have investigated why more senior workers tend to be paid higher wages than their less senior colleagues. Most empirical research has focused on job tenure as a continuous function of the time spent in the current job. This specification can be defended by theories of firm-specific investment, efficiency-wages or adverse-selection models. However, rent extracting arguments as suggested by the theory of internal labor markets, indicate that the relative position of the worker in the seniority hierarchy of the firm, her 'seniority rank', may also explain part of the observed returns to tenure. We build a theoretical framework based on the stochastic evolution of the firm's labour demand and a Last-In-First-Out hiring-firing rule for its workforce, that justifies this idea. The predictions of our model are tested on exhaustive linked employer-employee data from Denmark and Portugal. In agreement with the main prediction, we find a significant and negative impact of the seniority rank on wages in Portugal and an insignificant one in Denmark. This is consistent with the fact that labor protection increases the bargaining power of individuals with lower seniority rank (older in the firm relative to their peer workers), as predicted by theories on unionized and insider-outsider markets.
Stochastic demand; Seniory rank; Last-In-First-Out; Efficient bargaining matched employer-employee data