The Cross-Section of Labor Leverage and Equity Returns*
January 2017
Working Paper Number:
CES-17-70
Abstract
We study labor-induced operating leverage. Theoretically, we show that if labor markets are frictionless, two sufficient conditions for the existence of labor leverage are (a) relatively smooth wages and (b) a capital-labor elasticity of substitution strictly less than one. Our model provides theoretical support for the use of labor share'the ratio of labor expenses to value added'as a measure of labor leverage. We provide evidence for conditions (a) and (b), and we demonstrate the economic significance of labor leverage: High labor-share firms have operating profits that are more sensitive to economic shocks and have higher expected returns.
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macroeconomic,
earnings,
corporate,
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equity,
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Federal Reserve Bank of Chicago
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