Labor Leverage, Equity Risk, and Corporate Policy Choice

Posted: 13 Nov 2003

See all articles by Joshua G. Rosett

Joshua G. Rosett

Claremont McKenna College - Robert Day School of Economics and Finance

Abstract

This paper investigates the role of labor utilization in assessing equity investment risk and corporate financial policy choices. Several existing models of the firm predict that labor utilization is costly to adjust in the short run. I argue that this leads to a relatively fixed obligation to pay cash to labor, in effect creating an off-balance-sheet intangible liability similar to a lease. The liability creates 'labor leverage' risk, analogous to financial leverage risk. Labor leverage is hypothesized to be positively correlated with equity investment risk as measured by characteristics of stock returns. Managers recognize this risk and adjust financial policies including debt financing and dividend policy accordingly. The main empirical results are that labor leverage is positively correlated with equity investment risk, and it plays the predicted role in regressions explaining financial structure and dividend policy. Proxies for labor leverage are simple measures based on existing disclosure. The results are consistent with the conjectures that market participants use labor disclosures to assess risk, and that managers take actions to mitigate this risk. The results are consistent across most sectors of the economy, and consistent over time.

JEL Classification: M41, M44, M45, G32, G35

Suggested Citation

Rosett, Joshua G., Labor Leverage, Equity Risk, and Corporate Policy Choice. European Accounting Review, Vol. 12, No. 4, 2003, Available at SSRN: https://ssrn.com/abstract=458140

Joshua G. Rosett (Contact Author)

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

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HOME PAGE: http://www.claremontmckenna.edu/academic/faculty/profile.asp?Fac=372

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