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Labor and Finance: Mortensen and Pissarides meet Holmstrom and Tirole

  • Pietro Garibaldi

In real life labor markets firms hold at all times a variety of liquid assets not invested in their core business. Such external use of funds acts as an insurance against future adverse financial shocks, and typically varies across firms and sectors. As a result, different firms use different degrees of financial leverage. This paper investigates the consequence of firms' use of funds on their hiring and firing policy. Using a standard matching model of unemployment, the paper finds an equilibrium interplay between the value of unemployment and financial conditions. Financial market imperfections- such as the probability of refinancing or firms' share of their pleadgeable income- affect equilibrium unemployment. In this sense, the paper brings together the work on liquidity by Holmstrom anf Tirole (2011) with the traditional Mortensen Pissarides (2004) model of equilibrium unemployment. The model implies also that at times of adverse financial shocks, firms that are more leveraged are more likely to liquiditate their assets and destroy jobs. Empirically, we test whether there is a causal link between firms leverage and job destruction at times of adverse financial shocks. We draw on firm-level data on employment adjustment matched with balance sheet records throughout the Great Recession and find that highly leveraged firms destroy more jobs during a financial crisis.

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Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 775.

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Date of creation: 2013
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Handle: RePEc:red:sed013:775
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Bengt Holmstrom & Jean Tirole, 1997. "Financial Intermediation, Loanable Funds, and The Real Sector," The Quarterly Journal of Economics, Oxford University Press, vol. 112(3), pages 663-691.
  2. Dale T. Mortensen & Christopher A. Pissarides, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Oxford University Press, vol. 61(3), pages 397-415.
  3. Donatella Gatti & Christophe Rault & Anne-Gael Vaubourg, 2010. "Unemployment and finance: how do financial and labour market factors interact?," William Davidson Institute Working Papers Series wp973, William Davidson Institute at the University of Michigan.
  4. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  5. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
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