Financial Distress and the Cost of Labor: Evidence from a Natural Experiment

25 Pages Posted: 5 May 2020

See all articles by David Pedersen

David Pedersen

Rutgers School of Business-Camden

Date Written: April 8, 2020

Abstract

Employees bear significant costs in bankruptcy. Theoretical models predict they will accept lower wages in the face of financial distress to avoid such costs. Using a natural experiment, I test this theory and find an exogenous increase in default risk causes a decrease in employee wages. The effect is economically meaningful: the reduction in aggregate annual wages equals 10% of the firm’s earnings and 33% of its interest expense. As expected, it is concentrated in financially vulnerable firms and those with fewer agency conflicts. Employees thus represent an important financial resource for firms in the midst of financial distress.

Keywords: Labor, Finance, Negotiations

JEL Classification: G32, G33, J31

Suggested Citation

Pedersen, David, Financial Distress and the Cost of Labor: Evidence from a Natural Experiment (April 8, 2020). Review of Financial Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3571715

David Pedersen (Contact Author)

Rutgers School of Business-Camden ( email )

227 Penn Street
Camden, NJ 08102
United States

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