A Discrete Choice Approach to Estimating Workers’ Marginal Valuation of Fringe Benefits

This paper offers a new way of estimating workers’ valuation of fringe benefits using data on workers’ choices among fringe benefits packages offered by the employer. This approach overcomes both the omitted variable problem and the identification problem that bias estimates of compensating differentials and supply and demand parameters for fringe benefits from the traditional hedonic model most frequently used to analyze this problem. With this approach, the observed choice among offered fringe benefits packages which require different employee contributions and receive different employer subsidies conveys information about how much in wages workers are willing to give up to obtain additional firm dollars in the form of fringe benefits. That is the valuation of fringe benefits that we want to estimate. The comparison among alternatives implicit in the discrete choice method differences away fixed unobservable individual productivity differences that are believed to be the main problem in estimating compensating differentials and lessens the endogeneity problems that arise in estimating hedonic demand parameters. Variation in the offered wage-fringe price across firms identifies workers’ valuation of fringe dollars, serving the same function as the sometimes arbitrary market boundaries that must be imposed in the hedonic model to achieve identification. Exploratory empirical results using grouped firm data on choices of alternative health insurance plans provide support for the proposed approach. Unlike most estimates of compensating differentials for fringe benefits, the estimates are of the correct sign. The results suggest that families value health benefits substantially more than singles and that that valuation of fringe benefits dollars is substantially less than one-for-one with wage dollars.