Adjustment Costs and Factor Demand: New Evidence from Firmss Real Estate

Abstract

Adjustment costs impair the optimal allocation of production factor across firms. In this paper, we use the cost associated with corporate relocation to explore the effect of the adjustment costs of the premises size on factor demand. We rely on the tax on realized capital gains on real estate asset, which entails varying real estate adjustment costs across firms, to empirically study the effect of these frictions on firms' behaviour. We develop a general equilibrium model, with heterogeneous firms, that sheds light on the implication of the level of the fixed costs associated with the adjustment of real estate on the change in firms' labor demand following productivity shocks. This model predicts that employment growth of firms facing positive productivity shocks shrinks with the level of the frictions. Confronting these results using French firm-level data over the period 1994-2013, we find that higher adjustment costs constrain relocation and reduce job creation of the most dynamic firms. The highlighted frictions have noticeable macroeconomic effects.