Working Paper

The Cross-Section of Labor Leverage and Equity Returns


Abstract: 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;

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Bibliographic Information

Provider: Federal Reserve Bank of Chicago

Part of Series: Working Paper Series

Publication Date: 2017-09-04

Number: WP-2017-22

Pages: 60 pages