The cross-section of labor leverage and equity returns

By A. Donangelo, François Gourio, Matthias Kehrig, M. Palacios. Journal of Financial Economics, 2016

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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.

Subfields: Accounting, Finance, Strategy and Management

View Paper: https://www.semanticscholar.org/paper/25868588ce73219a9409fafe7215ca98532763f3