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Identification and Inference for Econometric Models: Essays in Honor of Thomas Rothenberg

This paper presents evidence that firms choose conservative financial policies partly to mitigate workers' exposure to unemployment risk. We exploit changes in state unemployment insurance laws as a source of variation in the costs borne by workers during layoff spells. We find that higher unemployment benefits lead to increased corporate leverage, particularly for labor-intensive and financially constrained firms. We estimate the ex ante, indirect costs of financial distress due to unemployment risk to be about 60 basis points of firm value for a typical BBB-rated firm. The findings suggest that labor market frictions have a significant impact on corporate financing decisions.

Labor unemployment risk and corporate financing decisions

We show that corporate bankruptcy leads to a significant reduction in employee earnings, which in turn increases financial distress costs for firms via higher ex ante wages. Annual employee earnings deteriorate by 10% when a firm files for bankruptcy and remain below pre-bankruptcy earnings for at least six years. Affected employees are likely to work fewer hours and leave the firm, industry, and local labor market. We estimate that compensating wage differentials for this “bankruptcy risk” increase the present value of ex ante wages paid by the firm by up to 12% of annual wages. Overall, this paper shows that bankruptcy risk reduces risk-sharing between the firm and workers, and the resulting additional labor costs are large enough to be a first-order consideration in corporate capital structure decisions.

/pdf/employee-costs-of-corporate-bankruptcy-5691o83ljl.pdf

Employee Costs of Corporate Bankruptcy

An employee's annual earnings fall by 13% the year her firm files for bankruptcy, and the present value of lost earnings from bankruptcy to six years following bankruptcy is 87% of pre-bankruptcy annual earnings. More worker earnings are lost in thin labor markets and among small firms. Ex-ante compensating wage differentials for this “bankruptcy risk” are up to 2% of firm value for a firm whose credit rating falls from AA to BBB, comparable in magnitude to debt tax benefits. Thus, wage premia for expected costs of bankruptcy are sufficiently large to be an important consideration in capital structure decisions. This article is protected by copyright. All rights reserved 

https://onlinelibrary.wiley.com/doi/pdfdirect/10.1111/jofi.13251

We combine U.S. Census data with SEC enforcement actions to examine employees’ outcomes, such as wages and turnover, before, during, and after periods of fraudulent financial reporting. We find that fraud firms’ employees lose about 50% of cumulative annual wages, compared to a matched sample, and the separation rate is much higher after fraud periods. Yet, employment growth at fraud firms is positive during fraud periods; these firms overbuild and hire new, lower-paid employees as part of the fraud, unlike firms in distress which tend to contract. When the fraud is revealed, firms shed workers, unwinding this abnormal growth and resulting in most of the negative wage consequences. Low wage employees, though unlikely to have perpetrated the fraud, experience more severe wage losses. Other sample splits show that negative wage effects are larger in thin labor markets and for fraud firms that go bankrupt.

/pdf/fraudulent-financial-reporting-and-the-consequences-for-4xdh5qpt0x.pdf

Fraudulent Financial Reporting and the Consequences for Employees

We provide new estimates of the wage costs of firms’ debt using an empirical approach that exploits within-firm geographical variation in workers’ expected unemployment costs due to variation in local labor market in a large sample of public firms. We find that, following an increase in firm leverage, workers with higher unemployment costs experience higher wage growth relative to workers at the same firm with lower unemployment costs. Overall, our estimates suggest wage costs are an important component in the overall cost of debt, but are not as large as implied by estimates based on ex post employee wage losses due to bankruptcy; we estimate that a 10 percentage point increase in firm leverage increases wage compensation for the median worker by 1.9% and total firm wage costs by 17 basis points of firm value.

Firm Leverage, Labor Market Size, and Employee Pay

We provide new estimates of the wage costs of firms' debt. Our empirical approach exploits within-firm geographical variation in workers' expected unemployment costs due to variation in local labor market size and uses a large representative sample of public firms. We find that, following an increase in firm leverage, workers with higher unemployment costs experience higher wage growth relative to workers at the same firm with lower unemployment costs. Overall, our estimates suggest that a 10 percentage point increase in leverage increases wage compensation for the median worker by 1.9% and total firm wage costs by 17 basis points of firm value.

/pdf/firm-leverage-labor-market-size-and-employee-pay-47fn3rvrbg.pdf

We show that newly hired workers earn higher wages in response to higher firm leverage. Consistent with compensating differential models, these higher wages appear to reflect compensation for the risk of earnings losses in the event of financial distress. For tenured workers, increases in leverage are not associated with higher wages. Our findings suggest that the wage costs of debt and optimal capital structure for a firm depend on expected employee turnover, as well as on the firm's future growth and hiring plans. Variation in local labor market conditions also significantly affects the relationship between firm leverage and employee pay. (JEL G32, G33, J21, J31, J61) Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

When Does Higher Firm Leverage Lead to Higher Employee Pay?

I study the effect of investment in young, private firms by venture capitalists (VC) on public firms in the same industry. I construct an instrument for VC investment that relies on individual VC's investment histories, holdings of equity stakes in IPO firms, and aggregate market returns immediately following those IPOs. I find that increased VC investment has a large effect on incumbent profitability. The effect arises due to higher costs and not depressed sales. The effect is short lived as firms respond by reallocating resources away from treated markets and by reducing their use of labor.

/pdf/venture-capital-and-the-performance-of-incumbents-pliexjmd5g.pdf

Venture Capital and the Performance of Incumbents

Over the course of the COVID-19 pandemic, state and local governments have instituted a wide array of restrictions on activity, easing or tightening these restrictions as concerns about transmission evolved. The particular choices that governments made could have large impacts on both public health and on economic prosperity. In this note, we provide evidence on the correlation between the level of these restrictions and a key component of the vitality of local economies, namely small businesses. We find that, in states with tighter restrictions, a greater proportion of small businesses generally reported levels of significantly curtailed operations than in states with looser restrictions throughout the pandemic, although this relationship weakens by the summer of 2021. In addition, states with tighter restrictions experienced a larger increase in small business loan default rates. At the same time, it appears that the Paycheck Protection Program helped to mitigate effects of government-imposed restrictions on small business health.

Economic Restrictions during the COVID-19 Pandemic and Measures of Small Business Health

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Papers

Firm Leverage, Labor Market Size, and Employee Pay

Firm Leverage, Labor Market Size, and Employee Pay

When Does Higher Firm Leverage Lead to Higher Employee Pay?

Venture Capital and the Performance of Incumbents

Economic Restrictions during the COVID-19 Pandemic and Measures of Small Business Health