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Labor and the Market Value of the Firm

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  • Merz, Monika

    ()
    (University of Vienna)

  • Yashiv, Eran

    ()
    (Tel Aviv University)

Abstract

What role does labor play in firms’ market value? We explore this question using a production-based asset pricing model with frictions in the adjustment of both capital and labor. We posit that hiring of labor is akin to investment in capital and that the two interact, with the interaction being a crucial determinant of market value behavior. We use aggregate U.S. corporate sector data to estimate firms’ optimal hiring and investment decisions and the consequences for firms’ value. We then decompose this value, thereby quantifying the link between firms’ market value and gross hiring flows, employment, gross investment and physical capital. We find that a conventional specification – quadratic adjustment costs for capital and no hiring costs – performs poorly. Rather hiring and investment flows, unlike employment and capital stocks, are volatile and both are essential to account for market volatility. A key result is that firms’ value embodies the value of hiring and investment over and above the capital stock.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 965.

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Length: 53 pages
Date of creation: Dec 2003
Date of revision:
Publication status: published in: American Economic Review, 2007, 97 (4), 1419 - 1431
Handle: RePEc:iza:izadps:dp965

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Keywords: gross flows; Q-model; labor market frictions; production-based asset pricing; GMM;

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  1. R. Glenn Hubbard & Anil K Kashyap & Toni M. Whited, 1993. "Internal Finance and Firm Investment," NBER Working Papers 4392, National Bureau of Economic Research, Inc.
  2. Russell W. Cooper & John C. Haltiwanger, 2000. "On the Nature of Capital Adjustment Costs," NBER Working Papers 7925, National Bureau of Economic Research, Inc.
  3. Matthew D. Shapiro, 1984. "The Dynamic Demand for Capital and Labor," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 735, Cowles Foundation for Research in Economics, Yale University.
  4. Russell Cooper & Joao Ejarque, 2003. "Financial Frictions and Investment: Requiem in Q," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 710-728, October.
  5. Simon Gilchrist & Charles P. Himmelberg, 1995. "Evidence on the Role of Cash Flow for Investment," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 95-01, New York University, Leonard N. Stern School of Business, Department of Economics.
  6. Jason G. Cummins & Kevin A. Hassett & R. Glenn Hubbard, 1994. "A Reconsideration of Investment Behavior Using Tax Reforms as Natural Experiments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(2), pages 1-74.
  7. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, Econometric Society, vol. 50(1), pages 213-24, January.
  8. Robert E. Hall, 2002. "Industry Dynamics with Adjustment Costs," NBER Working Papers 8849, National Bureau of Economic Research, Inc.
  9. Simon Gilchrist & Charles Himmelberg, 1999. "Investment: Fundamentals and Finance," NBER Chapters, in: NBER Macroeconomics Annual 1998, volume 13, pages 223-274 National Bureau of Economic Research, Inc.
  10. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 67-140.
  11. Steven A. Barnett & Plutarchos Sakellaris, 1999. "A New Look At Firm Market Value, Investment, And Adjustment Costs," The Review of Economics and Statistics, MIT Press, vol. 81(2), pages 250-260, May.
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