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

Financial constraints matter for hiring when labor is not a purely variable factor of production.
The study of labor as a fixed or quasi-fixed factor of production dates back to Oi (1962). Fixed costs
associated with labor include investments in recruiting, hiring and training. Labor adjustment costs have
been used in many settings in the literature and play an important role in my paper. Hamermesh (1989)
uses a plant-level data set to examine the nature of labor adjustment costs at the micro level. He finds that
adjustment tends to be lumpy, indicating that labor adjustment costs contain a significant fixed component
rather than purely convex costs that would imply smoother adjustment. Further, Hamermesh (1995) studies
the source of adjustment costs using a small set of establishments. He finds that both gross costs (of hiring
and firing) and net costs (of labor adjustment) affect dynamic labor demand, but that gross costs and the
turnover that helps generate them are most important. See also Hamermesh and Pfann (1996) for a review
of the literature on factor adjustment costs. 1
My paper is also related to the literature that seeks to understand the determinants of capital structure.
Starting from the idea that firms choose their capital structures base on an optimal tradeoff between tax ad-
vantages and distress costs, many researchers have concluded that observed leverage ratios appear puzzlingly
low (Graham 2000). This has spurred a large literature seeking to better understand the costs associated
with distress. Almeida and Philippon (2007) note that defaults cluster in bad times, so that the present value
of distress costs depend on risk premia. They find that accounting for these risk premia helps explain why
firms otherwise appear to use debt conservatively. Glover (2011) argues that there is selection bias in the
observed costs of distress, since firms with high distress costs will endogenously avoid these costs by using
less debt. Using a structural model, he estimates the unobserved distribution of distress costs, finding that
unconditional average distress costs are nearly twice as large as average costs conditional on distress. My pa-
per is consistent with the argument in Glover. I focus on the loss of human capital as a specific cost of default
and argue that firms with large amounts of human capital will choose debt conservatively to avoid losing
their human capital. This is similar to the argument made in Titman (1984). He argues that stakeholders
other than bondholders and shareholders are affected by financial distress and that optimal capital structure
will take account of the costs borne by these parties. While his model focuses on customers’ relationship
with a durable goods producer, Titman (1984) is clear that the same argument can be applied to suppliers
and workers.
1 A recent literature in asset pricing investigates the role of labor in determining prices (Merz and Yashiv 2007, Bazdresch,
Belo, and Lin 2009, Kuehn, Petrosky-Nadeau, and Zhang 2010, Donangelo 2011, Zanetti 2010). These papers generalize standard
neoclassical models to allow for frictions in the labor market, either in the form of exogenous adjustment costs to labor or through
search and matching frictions. They find that labor adjustment costs matter for returns in both the cross-section and in the
time series, and that accounting for labor market factors significantly improves the fit of asset pricing models.
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