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.
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Description: Full text
Provider: Federal Reserve Bank of Chicago
Part of Series: Working Paper Series
Publication Date: 2017-09-04
Pages: 60 pages