The Cross-Section of Labor Leverage and Equity Returns
Donangelo, Andres, Francois Gourio, Matthias Kehrig, and Miguel Palacios. "The cross-section of labor leverage and equity returns." Journal of Financial Economics 132, no. 2 (2019): 497-518
53 Pages Posted: 13 May 2016 Last revised: 29 Jun 2019
Date Written: September 1, 2016
Using a standard production model, we demonstrate theoretically that, even if labor is fully flexible, it generates a form of operating leverage if (a) wages are smoother than productivity and (b) the capital-labor elasticity of substitution is strictly less than one. Our model supports using labor share -- the ratio of labor expenses to value added -- as a proxy for labor leverage. We show evidence for conditions (a) and (b), and we demonstrate the economic significance of labor leverage: High labor-share firms have operating profits that are more sensitive to shocks, and they have higher expected asset returns.
Keywords: Labor Leverage, Capital-Labor Complementarity, Capital-Labor Elasticity of Substitution, Operating Leverage, Labor Share, Expected Returns
JEL Classification: G12, J2, J3
Suggested Citation: Suggested Citation