Untangling the Value Premium with Labor Shares
Review of Financial Studies, January 2021, 34(1), 451-508.
80 Pages Posted: 16 Nov 2017 Last revised: 19 Dec 2020
Date Written: September 26, 2019
This paper quantifies the relative importance of labor-induced operating leverage at explaining the value premium. I extend a traditional variance decomposition methodology using labor shares to disentangle labor leverage from the value premium and from the value spread and from the variation in profitability levels and growth. My extended decomposition shows that labor leverage explains approximately 50% of the value premium whereas profitability and growth based mechanisms explain the other 50%. I propose a tractable production-based asset-pricing model that qualitatively and quantitatively explains this finding, as well as the relation between book-to-market ratios, discount rates, profitability, and future growth.
Keywords: Labor Share, Labor Leverage, Operating Leverage, Value Premium, Value Spread, Growth Spread, Expected Returns
JEL Classification: G10, G12, E20
Suggested Citation: Suggested Citation