The Elephant in the Room: The Impact of Labor Obligations on Credit Markets
89 Pages Posted: 15 Jun 2016 Last revised: 23 Jan 2019
Date Written: January 18, 2019
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: Suggested Citation