American Economic Review Vol. 110 No. 6 2020

The Elephant in the Room: The Impact of Labor Obligations on Credit Markets

Jack Favilukis¹; Xiaoji Lin²; Xiaofei Zhao³

¹ Sauder School of Business, University of British Columbia (email: ) · ² Carlson School of Management, University of Minnesota (email: ) · ³ McDonough School of Business, Georgetown University (email: )

Abstract

We show that labor market frictions are first-order for understanding credit markets. Wage growth and labor share forecast aggregate credit spreads and debt growth as well as or better than alternative predictors. They also predict credit risk and debt growth in a cross section of international firms. Finally, high labor share firms choose lower financial leverage. A model with labor market frictions and risky long-term debt can explain these findings, and produce large credit spreads despite realistically low default probabilities. This is because precommitted payments to labor make other committed payments (i.e., interest) riskier.

DOI

10.1257/aer.20170156

Volume

110

Issue

6

Pages

1673-1712

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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