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Labor and the Market Value of the Firm

  • Monika Merz
  • Eran Yashiv

What role does labor play in a firm's 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 the time series behavior of market value. We use aggregate U.S. corporate sector data to estimate firms' optimal hiring and investment decisions and the consequences for firms' value. The model generates a good fit of the data. We decompose the estimated market value, thereby quantifying the link between firms' value and gross hiring flows, employment, gross investment flows, and physical capital. We find that a conventional specification -- quadratic adjustment costs for capital and no hiring costs -- performs poorly. Hiring and investment flows, unlike employment and capital stocks, are volatile and both are essential to account for market value 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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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0690.

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Date of creation: May 2005
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Handle: RePEc:cep:cepdps:dp0690
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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  1. Shapiro, Matthew D, 1986. "The Dynamic Demand for Capital and Labor," The Quarterly Journal of Economics, MIT Press, vol. 101(3), pages 513-42, August.
  2. Fumio Hayashi, 1981. "Tobin's Marginal q and Average a : A Neoclassical Interpretation," Discussion Papers 457, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. 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.
  4. Gilchrist, S. & Himmelberg, C.P., 1995. "Evidence on the Role of Cash Flow for Investment," Papers 95-29, Columbia - Graduate School of Business.
  5. 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.
  6. Russell W. Cooper & John C. Haltiwanger, 2000. "On the Nature of Capital Adjustment Costs," NBER Working Papers 7925, National Bureau of Economic Research, Inc.
  7. 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.
  8. 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.
  9. 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.
  10. Robert E. Hall, 2002. "Industry Dynamics with Adjustment Costs," NBER Working Papers 8849, National Bureau of Economic Research, Inc.
  11. 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.
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