Downward Wage Rigidity, Corporate Investment, and Firm Value

Abstract

In this paper, I assess whether labor market frictions affect corporate investment. To do so, I construct a downward wage rigidity measure, which proxies for the inability or unwillingness of firms to adjust wages downward, and show that firms reduce investment in the presence of downward wage rigidity. I also exploit staggered state-level changes in minimum wage rates as a source of exogenous variation in downward wage rigidity. I find that, following an increase in the minimum wage, firms reduce the investment rate (capital expenditure/capital stock) by 1.08 percentage points. Consistent with labor market frictions driving the investment cuts, the effect is more pronounced for firms with a higher fraction of minimum wage workers, higher employment protection, higher labor intensity, or stickier product prices. Downward wage rigidity exacerbates the debt overhang problem and increases operating leverage. I find that the investment cuts due to downward wage rigidity are efficient when firms have a tendency to overinvest. Overall, the findings suggest that labor market frictions affect corporate investment, and that they could play a positive role in improving firm value and production efficiency.