Defusing Leverage: Liquidity Management and Labor Contracts

58 Pages Posted: 9 Mar 2021

See all articles by Edoardo Maria Acabbi

Edoardo Maria Acabbi

Universidad Carlos III de Madrid

Andrea Alati

Bank of England

Multiple version iconThere are 2 versions of this paper

Date Written: January 19, 2021


Rigidities in firms’ payroll structures are likely to increase the transmission of shocks to firms’ cash flows and profitability. By using Italian administrative data on workers careers and firms’ balance sheets, we study how the use of permanent and fixed-term labor contracts affects this pass-through. We document how firms use the contract composition of their workforce to manage the risk determined by their labor-induced operating leverage. First, we confirm that a higher labor share is associated with more volatile cash flows following unexpected real shocks, a telling indication of operating leverage at work through labor costs. Second, we show that firms with a greater share of temporary contracts are characterized by a smoother time-series behavior of their cash-flows. In particular, the smoothing effect is stronger for firms with higher labor share related to the permanent workforce. We complement this analysis with the study of the 2001 labor market reform that lifted constraints on the creation of temporary contracts. Exploiting the staggered implementation of the reform across different collective bargaining agreements, we show that, following the reform, firms increased on average their share of temporary contracts and decreased average labor compensation. In addition, we show that, only among firms with an ex-ante more rigid labor cost structure, earlier transition to a more flexible workforce composition led to a 1 percentage point increase in profit margins (against a -1.6pp average variation around the event) and a 5 percent decrease in the cross-sectional standard deviation of profits.

Keywords: leverage, labor share, dual labor markets, liquidity, event-study

JEL Classification: E24, G30, J23, J24, J30, J41, J42, M55

Suggested Citation

Acabbi, Edoardo Maria and Alati, Andrea, Defusing Leverage: Liquidity Management and Labor Contracts (January 19, 2021). Available at SSRN: or

Edoardo Maria Acabbi (Contact Author)

Universidad Carlos III de Madrid ( email )

CL. de Madrid 126
Madrid, Madrid 28903


Andrea Alati

Bank of England ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

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