A test of the signalling hypothesis

Education may enhance earnings either because of human capital increases or by signalling-unobservable worker attributes. Previous tests of these alternatives relied on ad hoc distinctions between them. Our theoretical model provides a direct signal measure as the difference between required and necessary qualifications, forming the basis for an ordered-probit model of discrete differences between required and necessary qualifications that depend on firm, job, and worker attributes. Estimates support the model's predictions, providing a continuous, predicted signal measure for second-stage earnings equations. These results provide the first formal evidence of a significant, positive, gender-specific return to a signal and indicate a downward bias in the return to education from excluding the signal measure.