The Elephant in the Room: The Impact of Labor Obligations on Credit Markets

89 Pages Posted: 15 Jun 2016 Last revised: 23 Jan 2019

See all articles by Jack Y Favilukis

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance

Xiaoji Lin

University of Minnesota

Xiaofei Zhao

Georgetown University - Robert Emmett McDonough School of Business

Date Written: January 18, 2019

Abstract

We show that labor market frictions are first-order for understanding credit markets. Wage growth and labor share forecast aggregate credit spreads and debt growth as well as or better than alternative predictors. They also predict credit risk and debt growth in a cross-section of international firms. Finally, high labor share firms choose lower financial leverage. A model with labor market frictions and risky long-term debt can explain these findings, and produce large credit spreads despite realistically low default probabilities. This is because pre-committed payments to labor make other committed payments (i.e. interest) riskier.

Keywords: Wage rigidity, long-term debt, credit risk, labor market frictions, labor leverage, financial leverage, wage growth, labor share

JEL Classification: E23, E44, G12

Suggested Citation

Favilukis, Jack Y and Lin, Xiaoji and Zhao, Xiaofei, The Elephant in the Room: The Impact of Labor Obligations on Credit Markets (January 18, 2019). Available at SSRN: https://ssrn.com/abstract=2648763 or http://dx.doi.org/10.2139/ssrn.2648763

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Xiaoji Lin (Contact Author)

University of Minnesota ( email )

420 Delaware St. SE
Minneapolis, MN 55455
United States

Xiaofei Zhao

Georgetown University - Robert Emmett McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States

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