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Financial distress and the cost of labor: Evidence from a natural experiment
Author(s) -
Pedersen David J.
Publication year - 2021
Publication title -
review of financial economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.347
H-Index - 41
eISSN - 1873-5924
pISSN - 1058-3300
DOI - 10.1002/rfe.1105
Subject(s) - bankruptcy , financial distress , earnings , agency cost , economics , natural experiment , agency (philosophy) , labour economics , distress , finance , business , financial system , ecology , corporate governance , philosophy , statistics , mathematics , epistemology , biology , shareholder
Employees bear significant costs in bankruptcy. Theoretical models predict they will accept lower wages in the face of financial distress to avoid such costs. Using a natural experiment, I test this theory and find an exogenous increase in default risk causes a decrease in employee wages. The effect is economically meaningful: the reduction in aggregate annual wages equals 10% of the firm's earnings and 33% of its interest expense. As expected, it is concentrated in financially vulnerable firms and those with fewer agency conflicts. Employees thus represent an important financial resource for firms in the midst of financial distress.