Downward Wage Rigidity and Corporate Investment

Abstract

Firms reduce investment when facing downward wage rigidity (DWR), the inability or unwillingness to adjust wages downward. To document this fact, I construct DWR measures and exploit staggered state-level changes in minimum wage laws as an exogenous variation in DWR. Following a one standard deviation increase in the minimum wage, firms reduce their investment rate (the ratio of capital expenditure to capital stock) by 3.08 percentage points. The negative impact is more acute for firms with a higher fraction of minimum wage workers, stronger employment protections, or higher labor intensity. The investment reductions cannot be explained by labor adjustment under capital-labor complementarities. Rather, I identify the aggravation of debt overhang and increased operating leverage crowding out debt financing as two mechanisms by which DWR impedes investment. The findings highlight the unintended consequences of minimum wage policies on corporate investment.

Keywords: Downward Wage Rigidity, Corporate Investment, Minimum Wage Laws, Debt Overhang, Operating Leverage and Debt Financing

JEL Classification: D25, I38, J31, J38, K31