Payroll and Financial Leverage

56 Pages Posted: 5 Nov 2016 Last revised: 12 Sep 2022

See all articles by Li He

Li He

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM); Erasmus Research Institute of Management (ERIM)

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

He, Li, Payroll and Financial Leverage (September 1, 2022). Available at SSRN: https://ssrn.com/abstract=2864409 or http://dx.doi.org/10.2139/ssrn.2864409

Li He (Contact Author)

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM) ( email )

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HOME PAGE: http://https://www.rsm.nl/people/li-he/

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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