What Drives Firms' Hiring Decisions? An Asset Pricing Perspective

Abstract

In a neoclassical dynamic model of the firm with labor market frictions, optimal hiring is a forward-looking decision that depends on both discount rates and expected cash flows. Empirically, we show that: a) the aggregate hiring rate of publicly traded firms in the U.S. economy negatively predicts stock market excess returns and long-term cash flows both in-sample and out-of-sample, and positively predicts short-term cash flows; and b) through a variance decomposition, the time series variation in the aggregate hiring rate is mainly driven by changes in discount rates and short-term expected cash flows, each contributing to about 40% and 60% of the variation, respectively, with no contribution from variation in long-term expected cash flows. Through structural estimation of the model, we show that labor adjustment costs and time-varying risk are essential for the model to replicate the empirical patterns.

Keywords: Labor Hiring, Stock Returns, Dividend Growth, Simulated Method of Moments, Labor Adjustment Costs

JEL Classification: G12, E44