The Effect of Leverage on Labor Cost Management

[Purpose]The purpose of this study is to examine the effect of capital structure on managers’ labor cost management by focusing on the relations between leverage and hiring decisions. [Methodology]The research was conducted on firms that satisfy the sample selection criteria of this study in the Compustat database from 1976 to 2014. The wage model in Chemmanur, Cheng, and Zhang (2013) is used to test the hypotheses. [Findings]First, I find that firms with higher leverage hire fewer employees, consistent with the disciplining effect of debt. Second, I also find that leverage is negatively associated with total labor cost, which is the product of the number of employees and average employee wage. Finally, this effect is greater for firms with higher institutional shareholdings and higher bankruptcy risk. [Implications]My findings suggest that the effect of debt discipline and compensating wages simultaneously exist, but they affect firms’ human capital investment decisions through different channels. I show that debt disciplines manager to minimize overall labor costs, implying that the disciplining effect of debt on employee hiring outweighs the effect of debt on compensating wage documented in prior studies. The results also imply that labor cost management is crucial for firms facing greater bankruptcy risk.