Labor mobility and the cost of debt

Abstract

This paper empirically shows that the cost of debt financing is systematically higher for firms that operate in mobile labor markets. We posit two channels through which labor mobility could affect firms’ cost of debt: 1. higher default risk, due to an increase in cash flow volatility arising from the potential loss of valuable human capital assets, and 2. less pledgeable assets, given that a firm has limited control and ownership over the firm’s human capital. Using across U.S. state variations in the enforceability of non-compete agreements that restrict employee job switches as a proxy for anticipated labor mobility, and state-level reforms to non-compete laws to capture exogenous shocks to labor mobility, we find that labor mobility has a significantly positive relation with the credit spreads of U.S. corporate debt issued from 1990–2014. Moreover, our analysis reveals that the effect of labor mobility is greater for firms that are more reliant on human capital – i.e., high R&D firms and firms with greater organizational capital – which corroborates the main results. Overall, these findings suggest that investors price financial contracts by taking into account the risk that arises from labor mobility.