Labor Unemployment Risk and Corporate Financing Decisions

Abstract:     
This paper presents evidence that firms choose conservative financial policies partly to mitigate workers’ exposure to unemployment risk. We exploit changes in state unemployment insurance laws as a source of variation in the costs borne by workers during layoff spells. We find that higher unemployment benefits lead to increased corporate leverage, particularly for labor-intensive and financially constrained firms. We estimate the ex ante, indirect costs of financial distress due to unemployment risk to be about 60 basis points of firm value for a typical BBB-rated firm. The findings suggest that labor market frictions have a significant impact on corporate financing decisions.

Number of Pages in PDF File: 58

Keywords: capital structure, financial distress, unemployment risk, compensating wage differentials

JEL Classification: G32, G33, J31, J65

Accepted Paper Series