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The Cross-Section of Labor Leverage and Equity Returns*

Andres Donangelo, Francois Gourio (), Matthias Kehrig and Miguel Palacios

Working Papers from U.S. Census Bureau, Center for Economic Studies

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.

Date: 2017-01
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https://www2.census.gov/ces/wp/2017/CES-WP-17-70.pdf First version, 2017 (application/pdf)

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