The Cross-Section of Labor Leverage and Equity Returns
60 Pages Posted: 10 Nov 2017
Date Written: 2017-09-04
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, labor mobility, labor supply, wage, productivity
JEL Classification: J20, J22, J24, J62
Suggested Citation: Suggested Citation