The purpose of this paper is to develop a framework that allows one to distinguish between the extent to which differences in firm productivity are intrinsic and the proposition that higher paying firms employ more able workers. For this purpose, we adapt the equilibrium stochastic model of firm size developed by Klette and Kortum (2002). The Klette-Kortum model is consistent with stylized facts on the distribution of firm size, firm growth rates and investment in product research and development by design. In the competitive labor market extension of the model developed and studied here, cross firm wage dispersion simply reflects differences in worker quality. However, if in addition differences in TFP exist holding worker quality constant, more productive firms have an incentive to employ more workers and invest more in future growth. In the paper, we show that Danish data on firm output, wages and employment are consistent with firm specific differences in TFP. Furthermore, the derived measure of firm TFP is strongly correlated with measures of firm size. In sum, this evidence supports the view that a firm's productivity is more than the sum of the productivities of its workers
