Abstract
This paper shows whether labor costs affect firm capital investment and stock returns. I estimate wage premium across U.S. industries to find the negative investment-return relation predicted by q-theory is steeper for high wage firms than low wage firms. I highlight two important features for the mechanism at work: 1) increasing labor adjustment costs with wage, and 2) gross complementarity between capital and labor. In addition to the investment spread, I present implications of wage differentials on hiring spread, value premium, and corporate investment between firms. Overall, my results provide supportive evidence for investment-based model with factor adjustment costs.
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