Equilibrium Default and the Unemployment Accelerator

We provide evidence of a significant and persistent negative relation between a firm's workers and her probability to default. In contrast with most "macro-finance" models, this relation is robust to controlling for the several firm's variables, such as the firm's leverage and profitability. In particular, for a panel of most US publicly traded firms, we find that a 10% increase in a firm's workers is associated with a 3% decline in her probability to default. To account for this fact, we extend a standard search-friction labor-market model to incorporate firms default risk. This environment provides a micro-foundation where workers determine the firm's value, and consequently affecting her incentives to default. We argue that fluctuations in the value of a worker generate and significantly amplify business cycle fluctuations. In the context of our model, we find that fluctuations in the value of a worker explain more than 68% of credit spreads volatility, and almost 80% of default rate volatility.