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A Structural Model of Human Capital and Leverage

44 Pages Posted: 26 May 2016  

Ryan Pratt

Brigham Young University

Date Written: November 1, 2013


I study the effect of human capital on firms' leverage decisions in a structural dynamic model. Firms produce using physical capital and labor. They pay a cost per employee they hire, thus investing in human capital. In default a portion of this human capital investment is lost. The loss of human capital constitutes a significant cost of financial distress. Labor intensive firms are more heavily exposed to this cost and respond by using less leverage. Thus the model predicts a decreasing relationship between leverage and labor intensity. Consistent with this prediction, I show in the data that high labor intensity leads to significantly less use of debt. In the model a move from the lowest to the highest decile of labor intensity is accompanied by a drop in leverage of 21 percentage points, very close to the 27 percentage point drop in the data. Overall, I argue that human capital has an important effect on firm leverage and should receive more attention from capital structure researchers.

Keywords: Capital Structure, Human Capital, Corporate Finance

JEL Classification: G30, G32

Suggested Citation

Pratt, Ryan, A Structural Model of Human Capital and Leverage (November 1, 2013). Available at SSRN: or

Ryan Pratt (Contact Author)

Brigham Young University ( email )

640 TNRB
Provo, UT 84602
United States
(801) 422-1222 (Phone)

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