Labor and Capital Dynamics under Financing Frictions

Labor and Capital Dynamics under Financing Frictions

By Ryan Michaels, T. Beau Page and Toni M. Whited

Published in the Review of Finance


We assemble a new, quarterly panel dataset of U.S. firms that links firms’ investment and financing decisions to their employment and wages. We find that wages and leverage are strongly negatively related, both cross-sectionally and within firms, while the negative link between employment and leverage is smaller and less robust. We interpret these facts in a model that integrates a theory of costly debt and equity financing with rich firm-level dynamics, including labor and capital adjustment frictions and wage setting. Estimation of the model’s parameters shows that the model can reconcile several moments relating to debt, wages, employment, and investment. We find that both financing frictions and labor bargaining are important for inducing a negative relation between debt and leverage, both qualitatively and quantitatively. Our counterfactuals show that raising financing costs reduces employment and wages, in line with recent reduced-form evidence.

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