Payroll and Financial Leverage

I examine how payroll rigidity affects corporate financing decisions by estimating a dynamic model in which investment, employment, and financing decisions are determined endogenously as a result of exogenous labor market frictions. I find that, after negative productivity shocks, firms' inability to cut payroll leads them to reduce leverage; after positive productivity shocks, firms avoid hiring new workers in anticipation of payroll rigidity, allowing them to increase leverage. A structural estimation ascertains the model's ability to fit the data. Model predictions are confirmed by a difference-in-differences analysis that exploits the Senior Citizens' Freedom to Work Act of 2000 as an exogenous shock to payroll rigidity.