Human Capital, Capital Structure, and Employee Pay: An Empirical Analysis

Abstract

We test the predictions of Titman (1984) and Berk, Stanton, and Zechner (2010) by examining the effect of leverage on labor costs. Leverage has a significantly positive impact on CEOs’ cash, equity-based, and total compensation. Compensation of new CEOs hired from outside the firm is positively related to prior-year firm leverage. In addition, leverage has a positive and significant impact on average employee pay. The incremental total labor expenses associated with an increase in leverage are large enough to offset the incremental tax benefits of debt. The empirical evidence supports the theoretical prediction that labor costs limit use of debt.

Keywords: Capital structure, Human capital, Labor costs

JEL Classification: G32, J31