Labor Hiring, Investment, and Stock Return Predictability in the Cross Section

Abstract:     
We study the impact of labor market frictions on asset prices in the cross section. In stock return predictability regressions a 10% increase in the firm’s hiring rate is associated with a decrease of 1.3% to 1.8% in the firm’s annual expected stock return. We propose an investment-based asset pricing model with labor and capital stochastic adjustment costs to explain the negative correlation between hiring and risk premiums. Firms with relatively high hiring rates are expanding firms that face high adjustment costs. If the economy experiences a shock that lowers adjustment costs, these firms will benefit the most from these lower costs, allowing these firms to grow faster and make profits more quickly. The corresponding increase in value of these firms during these times is a hedge against adjustment cost shocks which explains the lower expected returns of these firms in equilibrium. With quasi-fixed labor, the model quantitatively matches the predictability of hiring, key properties of the firm-level hiring and investment rates, and other empirical regularities.

Number of Pages in PDF File: 52

Keywords: Labor Hiring, Investment, q-Theory, Cross-Sectional Asset Pricing, Production-Based Asset Pricing

JEL Classification: E22, E23, E44, G12

working papers series