Labor Intensity, Risk and Return

Abstract

I analyze the relationship between labor intensity -- the wages to revenue ratio -- and a firm's risk and book-to-market ratio in a production model. Under plausible parameters, labor intensive firms are riskier and exhibit higher book-to-market ratios than capital intensive firms. Covariance with the stochastic discount factor grows with labor intensity so the return spread between labor and capital intensive firms should explain the cross-section of stock returns. I provide evidence that labor intensive firms do appear riskier than capital intensive firms and that the spread between labor and capital intensive firms helps explain the cross-section of stock returns.