Considerable heterogeneity has been documented for both firm labor
productivity and average wages paid by firms within developed industrial
countries and the two are positively correlated across firms. These
observations can be rationalized by either exogenous heterogeneity in firm
productivity and a wage setting mechanism with rent sharing or by
differences in capital intensity and in the quality of labor inputs. The
purpose of this paper is to ascertain the extent to which these factors
provide an explanation of the observations using matched employer-employee
data for Denmark. Using the worker fixed effect in a wage equation as a
measure of worker quality, we find that capital intensity and labor input
quality differences explain little of the observed labor productivity
heterogeneity in manufacturing but are the principal explanation for
differences in firm wages paid. However, both labor quality differences and
rent sharing are important in explaining the positive correlation between
average firm wage and labor productivity. Somewhat more mixed results hold
for the other four industry groups considered.