Defusing leverage: liquidity management and labor contracts

59 Pages Posted: 22 Jan 2024

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: November 17, 2023

Abstract

This study employs Italian administrative data to investigate how the use of permanent and fixed term labor contracts influences the transmission of aggregate shocks to firms’ fundamentals. We explore how firms strategically manage their labor-induced operating leverage by adjusting the composition of contracts in their workforce. Our findings reveal two key insights. First, a higher labor share is associated with increased volatility in cash flows following unexpected real shocks, indicating the presence of operating leverage through labor costs. Second, firms with a greater proportion of temporary contracts exhibit lower variability in cash flows and profits. This smoothing effect is more pronounced in firms with a higher labor share attributed to the permanent workforce. We complement our analysis by examining the 2001 labor market reform that lifted restrictions on the creation of temporary contracts. Our results demonstrate that firms, following the staggered implementation of the reform, increased their utilization of temporary contracts while reducing average labor compensation. Furthermore, we find that, only among firms with an ex-ante more rigid labor cost structure and in more concentrated labor markets, the earlier transition to a more flexible workforce composition led to a sizable increase in profit margins and a decrease in the cross-sectional standard deviation of profits

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

JEL Classification: G12, E23, J23

Suggested Citation

Acabbi, Edoardo Maria and Alati, Andrea, Defusing leverage: liquidity management and labor contracts (November 17, 2023). Bank of England Working Paper No. 1051, Available at SSRN: https://ssrn.com/abstract=4698308 or http://dx.doi.org/10.2139/ssrn.4698308

Edoardo Maria Acabbi (Contact Author)

Universidad Carlos III de Madrid ( email )

CL. de Madrid 126
Madrid, Madrid 28903
Spain

HOME PAGE: http://eacabbi.github.io

Andrea Alati

Bank of England ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

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