Payroll and Financial Leverage
56 Pages Posted: 5 Nov 2016 Last revised: 12 Sep 2022
Date Written: September 1, 2022
Abstract
Payroll rigidity incentivizes firms to use financial leverage to absorb shocks. I quantify the relative magnitudes of the underlying economic forces by estimating a dynamic model in which investment, employment, and financing decisions are determined endogenously as a result of exogenous labor market frictions. In the model, firms reduce leverage after negative productivity shocks because they cannot cut payroll. After positive productivity shocks, firms avoid hiring in anticipation of payroll rigidity, allowing them to increase leverage. I validate the model with a difference-in-differences analysis that exploits state changes in Social Security legislation as an exogenous shock to payroll rigidity.
Keywords: Payroll, Capital structure, Financial Leverage, Wage Rigidity
JEL Classification: G32, J30
Suggested Citation: Suggested Citation