Dr. P.V. Viswanath
Capital Structure and Labor Policies
P.V. Viswanath, 2013
Labor Market Effects and Human Resource Strategies:
Kuzmina (2012) points out that the ability to use more contractual labor on short-term contracts should reduce operating leverage. This, in turn, would allow the firm to increase financial leverage. It is not clear whether labor expenses in the US should be considered short-run or long-run. If they are short-run (i.e. workers can be fired easily), then there would be a positive contemporaneous, cross-sectional relationship between labor expenses and leverage, all other things being the same.
Cantor (1990) suggests that firms that are highly-leveraged may be more susceptible to restricting expenditures in times of cashflow stringency. On the other hand, when operating cashflows are high, they may have higher return to equity, which might prompt them to spend more. This pro-cyclicality in investment may also be reflected in hiring decisions. Empirically, Cantor finds a positive relation between a high leverage dummy (firms above the 80th percentile = 1) and the volatility of a firm's investment rate, as well as between the high leverage dummy and the volatility of a firm's employment growth rate.
Chemmanur et al. (2013) find that leverage causes executive pay as well as average employee compensation to be larger (to compensate employees for the greater risk of bankruptcy and job loss) and this, therefore, causes firms to limit their use of debt. They find a contemporaneous positive correlation between firm leverage and employee pay (as well as CEO pay).