Effects of the Asian Financial Crisis on the Relationship between Capital Structure and Employee Payments: Evidence of a Natural Experiment

Abstract

This study investigates the effects of the Asian financial crisis on the relationship between capital structure and employee wages, using the crisis as a natural experiment in a leading emerging market. The unemployment rate increases during the Asian financial crisis owing to massive layoffs and the bankruptcy of many firms. This unemployment rate shock is an exogenous shock in the individual firms’ perspectives. We show that the increased unemployment rate during the Asian financial crisis weakens the negative relationship between debt ratios and employee wages. During high unemployment periods, it becomes difficult for employees to find alternative new jobs. Consequently, employees require highly levered firms to pay high wages in order to compensate for their human capital risk. This research confirms the time-varying relationship between firms’ leverage and employee wages according to the unemployment rate without the endogeneity problem.