A Structural Model of Human Capital and Leverage - Duke ...

the interpretation of the results in recent empirical papers on labor and corporate finance as well as open up
avenues for future research in this area.
In a closely related theoretical paper, Berk, Stanton, and Zechner (2010) write a model in which firms
sign long term wage contracts with employees. Bankruptcy limits the ability of the firm to commit to the
long term contract, thus introducing a cost of debt. The firm trades off this cost against the tax advantages
of debt to determine the optimal capital structure. While the mechanism in my model is similar, there are
a number of important differences. In Berk, Stanton, and Zechner (2010) the focus is on solving for the
optimal dynamic wage contract. In order to do so a number of simplifying assumptions are made. In their
model, the capital structure decision is static, there is no hiring or firing outside of bankruptcy, there is
no investment decision, and debt is risk-free. In my model, I focus on the dynamics of capital structure,
taking the structure of the wage contract as given. I endogenize investment and hiring, which allows me to
study their interactions with financing and to assess their quantitative importance. The previous structural
corporate finance literature has demonstrated that investment is a key driver of leverage (Hennessy and
Whited 2005, Hennessy and Whited 2007, Gomes and Schmid 2010). Since investment and hiring policies
interact, it is important to allow for both to be endogenous in a model that analyzes the importance of human
capital.
The idea of bankruptcy limiting the firm’s ability to commit to long-term contracts is key in Butt-Jaggia
and Thakor (1994) as well. They write a model in which workers choose to allocate their time between
firm-specific and general investment activities. Their focus is on the moral hazard problem of workers under-
investing in firm-specific activities because these activities lack value in the outside labor market. Long-term
contracts help to mitigate this moral hazard, but such contracts do not survive bankruptcy. Thus, debt is
costly in that it makes it more difficult for the firm to induce firm-specific investments. A similar cost of debt
is emphasized in the model of Qian (2003). She argues, as I do, that these costs of debt are more significant
for labor intensive firms and provides empirical evidence to support the theoretical claim that leverage and
human capital intensity should be negatively related. In these models the source of relationship-specific
surplus is firm-specific human capital, whereas in my model it derives from costly job search. Furthermore,
in addition to predicting the direction of the relationship between human capital and leverage, I evaluate its
quantitative significance.
In a recent empirical paper motivated by the costs of financial distress borne by employees, Agrawal and
Matsa (2010) use variation in state unemployment benefits to estimate the effect of unemployment risk on
corporate financing policies. When unemployment benefits become more generous, the cost to workers of
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