Bryan Caplan explains (in The Case Against Education), the sheepskin effect:
Graduation tells employers, “I take social norms seriously—and have the brains and work ethic to comply.” Quitting tells employers, “I scorn social norms—or lack the brains and work ethic to comply.” If you graduate, the signaling model says the market will lump you with the winners and pay you a special diploma bonus—often called a “sheepskin effect” because diplomas used to be printed on sheepskin. If you quit, the signaling model says the market will lump you with the losers and withhold the sheepskin’s reward. After all, employers won’t know why you failed to finish your degree. They’ll only know you failed.
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High school graduation has a big spike: twelfth grade pays more than grades 9, 10, and 11 combined. In percentage terms, the average study finds graduation year is worth 3.4 regular years. College graduation has a huge spike: senior year of college pays over twice as much as freshman, sophomore, and junior years combined. In percentage terms, the average study finds graduation year is worth 6.7 regular years. Results are similar for advanced degrees; in several studies, their payoff is nothing but a sheepskin effect.
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One-third of the U.S. population spends 12 years in school, gets a high school diploma, then stops. Only 2% quit high school right after eleventh grade. One-seventh spends 16 years in school, gets a bachelor’s degree, then stops. Only 2% quit college right after their junior year.
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The GSS is ideal for isolating sheepskin effects: 99.5% of participants declare both their years of education and their highest completed degree. Ignoring degrees, the GSS features a large education premium: take another year of school, get a 10.9% raise. Correcting for degrees, however, this annual payoff plummets to 4.5%. Over 60% of the education premium turns out to be a sheepskin effect. High school and four-year college diplomas are especially lucrative: crossing each of these thresholds boosts income by almost a third. As expected, the most lucrative years are also the most popular. Thirty percent have a high school diploma with exactly 12 years of schooling; only 5% finish 11 years but not 12. Eleven percent have a bachelor’s degree with exactly 16 years of school; only 3% finish their junior year but not their senior year.