Handbook of Corporate Finance: Labor and Corporate Finance PDF

Handbook of Corporate Finance Edited by David Denis Chapter on Labor and Corporate Finance Naman Nishesh∗ Paige Ouimet† Elena Simintzi‡ This Draft: October 2022...

Handbook of Corporate Finance Edited by David Denis Chapter on Labor and Corporate Finance Naman Nishesh∗ Paige Ouimet† Elena Simintzi‡ This Draft: October 2022 Abstract In this chapter, we review several key topics that lie at the intersection between labor economics and corporate finance. We discuss well-studied questions in this literature as well as new areas of research that are expanding the field of labor and corporate finance. First, we address the relationship between ownership and employees’ labor outcomes. Second, we present an overview of the literature studying the relationship between capital structure and labor markets, including the implications of financial distress. Third, we connect labor with the fast-growing literature on inequality within firms and investments in technology adoption. A common theme across all these topics is the interdependency between firms and labor, where decisions made by firms impact labor and trends in labor markets impact firms. ∗ University of North Carolina; Email: [email protected] † University of North Carolina; Email: [email protected] ‡ University of North Carolina and CEPR; Email: [email protected] We are grateful to David Denis (the Editor), Alan Benson, Jonathan Berk, Claire Célérier, Alex Edmans, Matthew Gustafson, Hyunseob Kim, David Matsa, Ernst Maug, Marco Pagano, Dimitris Papanikolaou, Yue Qiu, Daniel Rettl, Fabiano Schivardi, Matthew Serfling, and Miao Zhang for helpful comments. Electronic copy available at: https://ssrn.com/abstract=4214664 1 Introduction The economics literature has made important strides towards explaining the dynamics of labor markets. While that literature focuses on studying labor markets at the individual- sector- or economy- level, it has given less emphasis towards uncovering firm-level mechanisms driving these relationships or understanding the heterogeneity between firms. The field of corporate finance is focused on the role of firms but has traditionally concentrated on investments in cap- ital with less attention to labor. More recently, a new literature has emerged at the intersection of these two important fields seeking to better understand the interactions between firms and labor markets. This relationship between firms and labor is important to study because labor has some unique features that distinguish it from capital. Unlike capital, employees in a firm can make strategic decisions, allocate or withdraw effort and, most importantly, freely move across firms. As such, conclusions from the existing literature studying the relationship between firms and investments in capital will not always apply to investments in labor. Moreover, a unique set of frictions are present in labor markets, which in turn impacts firms and their decisions. Ultimately, labor is a key stakeholder in the firm and an important driver of firm value – a central focus of the corporate finance literature. The starting point in the labor and finance literature is the interdependency between firms and labor. On the one hand, firms impact labor markets. Decisions taken by firms can have first-order implications for their workers. For example, financing investment projects with excessive debt increases the likelihood of financial distress or bankruptcy, which in turn can result in monetary losses for employees. In addition, firm decisions to invest in technology directly impact workers by shifting demand for their labor and changing their compensation. On the other hand, attributes of the labor markets impact firms’ decisions and can have direct implications on firm value. For example, regulations that limit firms’ ability to restructure their labor force can have implications on firms’ financing and investment. Alternatively, job-search frictions may impede firms’ ability to expand and grow. 2 Electronic copy available at: https://ssrn.com/abstract=4214664  In the following chapter, we focus primarily on empirical papers at the intersection of labor and finance. This is not the first survey chapter to be written on this important literature. Pagano and Volpin (2008), Matsa (2018), and Pagano et al. (2020) have also written excellent surveys on the topic. In this review, we revisit the established literature but also, in reflection of the fact that the labor and finance field has expanded over time, cover new topics at the frontier of the labor and finance field. A key focus of corporate finance has been to understand how external providers of capital impact firm decisions. Some conclusions from this literature on financing and investment in capital apply to financing and investments in labor as well. However, this is not always the case given intrinsic differences between capital and labor. In Section 2, we start by looking at equity ownership and how this impacts labor. In Section 3, we explore instead the relationship between capital structure and labor markets. In both of these cases, external finance impacts labor and a firm’s workforce also impacts its financing. Next, we turn our attention to the topic of inequality. There are at least three reasons why researchers in the labor and finance field have become increasingly interested in this topic. First, it is now well understood that firms play a key role in generating inequality. As such, financial frictions, ownership changes, and managerial decisions can be important determinants of inequality. Second, inequality can impact firm value, an outcome of obvious interest to investors. Third, a growing subset of investors are asking firms to set compensation practices in a manner to address inequality. Thus, in Section 4, we explore how firms impact overall income inequality. In the final review section, we build upon the well-documented fact that inequality is related to technology adoption. As such, in Section 5, we cover the small but growing literature seeking to explain firm decisions to invest in technology and the implications of those decisions on labor outcomes and inequality. This topic is directly related to the corporate finance literature which seeks to understand firm investment decisions as well as to the labor literature given the implications of technology adoption on labor demand. In Section 6, we conclude by identifying important areas for future research. Given the 3 Electronic copy available at: https://ssrn.com/abstract=4214664 increasing availability of worker-level data, the field of labor and finance is likely to keep ex- panding as new data provides new insight to these important questions. 2 Ownership Changes and Labor Outcomes A change in ownership can lead to significant changes within the firm. In this section, we discuss how ownership changes interact with labor. One such important event in the life-cycle of some firms is the transition from private to public ownership that occurs when a firm completes an Initial Public Offering (IPO). The consensus in the literature is that while IPOs lead to a decline in innovative and entrepreneurial employees, they are associated with increases in overall employment. In contrast, transitions to private equity ownership have been associated with shifts in employment towards more skilled workers and mixed effects on employment levels. Furthermore, a large literature has studied post-M&A labor restructuring with several papers identifying labor as a key source of M&A synergies. Finally, we touch on other types of ownership changes including privatization and family ownership and their impact on labor. 2.1 Initial Public Offerings and Secondary Equity Offerings Initial Public Offerings (IPOs) are an important milestone for young firms with significant growth expectations. What are the tensions that call for an empirical investigation of the relation between IPOs and labor outcomes? First, IPOs remove financial constraints which may facilitate greater investment in labor. Second, the transition to public ownership could heighten agency conflicts as key employees will now have a diluted stake in the firm. Third, the short-term focus of public markets could lead firms to de-emphasize long-term experimentation, impacting the optimal mix of employees at the firm. And finally, IPOs could lead to a wealth shock among employees with equity stakes and, as a result, higher rates of turnover. Bernstein (2015) explores the effect of IPOs on firms’ incentives to innovate and the im- plications for inventors. The productivity of the inventors who remain at the firm declines 4 Electronic copy available at: https://ssrn.com/abstract=4214664 following the IPO and key inventors are more likely to leave, resulting in a firm-level decline in innovation. To ensure causality, Bernstein (2015) uses NASDAQ returns during the narrow book-building period – while controlling for longer-term market trends – to instrument for IPO completion. The identifying assumption is that fluctuations in NASDAQ returns while a firm is in the book-building phase will impact a firm’s ability to complete an IPO but is unlikely to be correlated with future firm performance, after controlling for longer-term market trends. This allows for a causal interpretation of the results which would not otherwise be possible when comparing outcomes for firms which successfully completed their IPO, as compared to firms which withdrew their IPO, given the concern that IPO success is correlated with firm quality. Borisov et al. (2021) follow the same identification strategy as in Bernstein (2015) but instead look at the impact of IPOs on total employment. The authors find that employment increases significantly after going public, and the increase is more pronounced among firms that were more likely to be financially constrained ex-ante and among firms operating in more human-capital intensive industries. Babina et al. (2020) instead look at the impact of IPOs on other labor outcomes, including wages and employee turnover. The authors find that following an IPO, firms hire lower-wage workers, as compared to their pre-IPO workforce, suggesting a change in the optimal mix of skills at the firm following the financing event. However, in order to attract these workers post-IPO, the issuing firm now pays a higher wage premium, measured as the gap between the new employee’s previous wage and the starting wage at the issuing firm, on average. The authors also document changes in employee turnover around the financing event, including an increase in employee departures to new firms. Bias et al. (2022) also find significant employee turnover following an IPO among a sample of German firms, consistent with an increase in hierarchical layers. Looking instead at seasoned equity offerings (SEOs), Kim et al. (2019) investigate impli- cations for labor using detailed data on investments and employment available for publicly traded Chinese firms. The authors study a regulatory shock which mandated that any firm issuing an SEO have met specific payout standards over the past three years. This regulatory action was unanticipated, allowing the authors to construct an instrument to identify a causal 5 Electronic copy available at: https://ssrn.com/abstract=4214664 relationship. Following an SEO, firms invest more in technology, thereby reducing their need for low-wage workers. Demand for high-skill workers increases, as technology and high-skill la- bor are complements, while net employment declines. Importantly, firm profitability increases, which suggests that these investments and changes to employment are value-enhancing. 2.2 Mergers and Acquisitions Another important change in ownership which has implications on labor is mergers and acquisi- tions (M&As). Labor can be a direct motivation for M&As, thereby influencing the distribution of these events. M&As can also have salient implications for labor. In this section, we review the extant literature on both these important topics. 2.2.1 Labor as Motivation for M&As Human capital can be a source of value creation from corporate takeovers. This arises from the fact that a firm’s labor force may be one of its most valuable assets. As compared to increas- ing employment via hiring, acquiring labor via an acquisition may be more efficient in certain situations. For example, acquiring labor via an acquisition may be particularly advantageous when seeking employees with unique or especially valuable skills. Ouimet and Zarutskie (2020) show that some firms pursue mergers specifically with an objective of “acquihiring”. Acquirers appear to disproportionately retain high-value employees in acquiring-labor-motivated acquisi- tions by providing these workers with relatively greater wage increases. Chen et al. (2021) find consistent results using the staggered adoption of the Inevitable Disclosure Doctrine (IDD), which prevents a firm’s existing employees from working for a peer firm if such a move will result in the disclosure of internal trade secrets. The adoption of the IDD makes it harder for firms to hire and, in response, M&A activity increases. Tate and Yang (2016) identify a separate channel by which labor can motivate M&A activity. In Tate and Yang (2015b), the authors show that internal labor markets lower the transaction costs of transferring human capital between industries, thereby facilitating communication and 6 Electronic copy available at: https://ssrn.com/abstract=4214664 collaboration between workers across different divisions. These collaborations can, in turn, improve worker productivity. In addition, the ability to transfer workers within the internal labor market can enable the firm to bypass frictions in external labor markets – such as search, termination, information, and training costs. Tate and Yang (2016) show that this potential for more efficient worker re-allocation can motivate M&As. The authors find that diversifying M&A activity is more common among firms with higher human capital transferability. Following such acquisitions, more high-skill employees remain at the merged firm and the merged firm experiences larger labor productivity gains. In related work, Beaumont et al. (2021) explore how labor impacts the buy or build question for firms entering new markets. They find that firms are more likely to enter via M&As, as compared to internal growth, in sectors that have less overlap with their current human capital. This suggests that firms use M&As to seize growth opportunities that they could not directly exploit by building on their existing human capital.1 In seminal work, Shleifer et al. (1988) argue that M&As can lead to a transfer in wealth from stakeholders to shareholders. One key mechanism they highlight is the ability of an acquirer to break implicit labor contracts, which could result in lower wages and cost savings and, hence, merger synergies. He and le Maire (2021) show evidence consistent with this argument. The paper documents the important role of managerial style in determining firm wages. Moreover, He and le Maire (2021) show that manager-specific wage premiums are associated with a higher probability of becoming a target. Consistent with this argument, there is a reduction in workers’ wages post-M&A, concentrated among firms with high-paying managers. A related argument is made in Pontiff et al. (1990) who find that pension fund plan reversions are more common following a takeover, particularly after hostile takeovers. Their evidence is consistent with some M&As being motivated, at least in part, as a means to benefit from reversion of over-funded pension plans. Conversely, labor can also be a deterrent to takeover activity. In important theoretical work, Pagano and Volpin (2005) show that workers can form alliances with management, where man- 1 More generally, firms have better information, as compared to outsiders, allowing for a better match between labor and capital within the boundaries of their firm, thereby creating value, as shown in Berk et al. (2017). 7 Electronic copy available at: https://ssrn.com/abstract=4214664 agers incentivize workers by providing higher wages and, in return, employees protect manage- ment from hostile takeovers. Consistent with this theory, John et al. (2015) find that acquirers in states with stronger labor protection realize, on average, lower returns upon announcement of an M&A, and Dessaint et al. (2017) find that an increase in labor protection decreases M&A activity as well as the gains from M&As, as measured by combined acquirer and target an- nouncement returns. In related work, Tian and Wang (2021) use a regression discontinuity design around close union elections to document a negative relation between unionization and takeover probability. 2.2.2 How Do M&As Impact Labor? Firms engage in M&As out of the belief that the merged firm will be more valuable, as compared to the sum of the target and acquirer as standalone firms. One such potential source of merger synergies is the ability to restructure labor, redeploying talent to higher productivity tasks and laying off redundant employees. Much of this literature builds on the original argument in Shleifer et al. (1988) that changes in ownership can be used to break implicit contracts with employees regarding future employment and wages. Using cross-country and time series variation in the degree of employment protection afforded by national laws and regulations, Dessaint et al. (2017) find that mergers are associated with lower combined firm employment, but this is mediated by employment protection laws. Li (2013) explores changes following takeovers in the manufacturing sector and finds lower wages and employment at target plants, as compared to a matched sample. He and le Maire (2021) find that, following acquisitions, target firms are more likely to replace high-paying managers and reduce workers’ wages. Lagaras (2020) innovates by using employee-employer matched data from Brazil to de- compose wage changes into wage changes borne by incumbent workers who stay versus wage changes that result from modifications in the composition of employment following the merger. The paper finds evidence of aggregate wage declines following M&As, however, this is entirely attributable to employee displacement. Workers who remain at the firm do not experience significant wage changes. In a contemporaneous paper, Gehrke et al. (2021) look at employee- 8 Electronic copy available at: https://ssrn.com/abstract=4214664 employer matched data in Germany. Gehrke et al. (2021) focus on the post-merger labor force for both the target and acquirer and document a significant increase in overall turnover post- merger with a sharp increase in labor flows between the target and acquirer. Overall, they find unequal effects on target and acquirer employees: job losses are concentrated at the target and job gains are concentrated at the acquirer. Ma et al. (2016) document more nuanced within-firm impacts on employment using data from the Bureau of Labor Statistics which measures occupational employment. In a first step, Ma et al. (2016) show that investment in information technologies (IT) increases post-merger. This has implications for labor, given the ability of technology to replace labor engaged in routine tasks and to complement high-skill employees. Consistent with routine-biased tech- nological change and skill-biased technological change, Ma et al. (2016) find that post-M&A, target firms employ fewer workers in routine-based occupations and relatively more workers in high-skill occupations. Moreover, given employees engaged in routine tasks tend to cluster in the middle of the income distribution, this leads to an increase in wage inequality. In comple- mentary work, Lagaras (2017) studies merger activity in Brazil to show that firms with larger shares of high-skilled and innovation-intensive employees participate in mergers. Post mergers, employment in knowledge-intensive occupations at target firms increases. More recent work highlights how employer concentration can impact employees post-M&As. Benmelech et al. (2022) find evidence of a negative correlation between local employer concen- tration and wages. Moreover, they show that M&As, which increase labor market monopsony power, negatively impact wages. In contemporaneous work, Prager and Schmitt (2021) find lower wage growth following mergers in the hospital sector which result in large increases in market concentration. The hospital sector is an ideal setting to test this argument given the limited cross-industry mobility of workers in health care occupations due to high levels of industry-specific skill. One challenge in this literature is assigning causality. Target firms could change their opti- mal technology ex-post due to the resolution of financial constraints, agency conflicts, or because the acquirer can integrate technology more efficiently. Alternatively, an omitted variable could 9 Electronic copy available at: https://ssrn.com/abstract=4214664 drive changes to both the labor demand and M&A activity. Multiple approaches have been used in the literature to argue for a casual interpretation of the results including matching control and target firms on observable characteristics, saturating models with fixed effects, comparing completed and exogenously cancelled M&As and showing cross-sectional patterns in treatment that are consistent with a causal interpretation. While a change in employment or pay is the first-order effect of takeovers on labor, takeovers could also impact employees on other important dimensions. To this end, Bach et al. (2021) use a novel dataset to study the impact of M&As on the mental health of employees. Uni- versal central healthcare access in Sweden enables the authors to match acquirer and target employees with their individual mental health outcomes. The takeaway from their analysis is that takeovers have a negative effect on employees’ mental health. Following a takeover, an incumbent employee’s likelihood of being diagnosed with mental illness increases by 3%. In sum, most of the early work documenting employment declines following M&As focused on manufacturing firms and blue-collar workers. More recently, several studies have comple- mented the literature by documenting more nuanced impacts on employees. First, takeovers lead to heterogeneous outcomes for employees. While average outcomes may be negative, M&As may not be detrimental for all employees. Second, M&As often prompt internal labor markets and can be associated with significant increase in employee turnover. This suggests that an- alyzing outcomes for incumbent employees at target firms may not capture the full extent of the impact takeovers have on labor. Finally, the impact of M&As on employees may depend on local labor market conditions. 2.3 Private Equity Buyouts While Private Equity (PE) buyouts have been associated with better firm governance and operating performance, thereby increasing returns for investors, concerns have been raised that such efficiencies may come at the expense of employees. In their survey paper, Kaplan and Strömberg (2009) summarize the literature to date as mixed. As compared to a matched sample 10 Electronic copy available at: https://ssrn.com/abstract=4214664 of control firms, buyout target firms add jobs at a slower rate. Kaplan (1989), Lichtenberg and Siegel (1990) and Davis et al. (2014) all document relatively lower employment growth at PE-owned firms. Critically, despite documenting relatively lower employment gains, all these papers document net employment gains, on average, at PE-owned firms – inconsistent with arguments of mass layoffs following PE buyouts. More recent papers on the topic have also failed to reach a consensus. Looking at a sample of French private equity deals, Boucly et al. (2011) find employment is 18% higher at leveraged buyout (LBO) targets, as compared to matched control firms. The difference, as compared to earlier studies, may be attributed to differences between France and the U.S., as all earlier studies focus on U.S. deals. Labor markets in France afford greater employment protections to their employees and capital and credit markets are relatively less developed, as compared to the United States. This is particularly important since private equity firms can relax financial constraints, especially at private target firms. Alternatively, Antoni et al. (2019) using a sample of German buyouts, find a five-year post-deal decline in employment of 8.96%, as compared to a control group. Davis et al. (2021b) take a step forward in explaining these mixed findings. Using a sample of buyouts from 1980 to 2013, the authors document significant heterogeneity in post- buyout employment changes. First, prior ownership matters. Buyouts of publicly listed firms are associated with employment declines of 13%, on average, while buyouts of private targets are associated with employment increases of 13%, on average, as compared to control firms. Second, macroeconomic conditions matter too. Post-buyout employment growth, relative to matched control firms, is slower when credit conditions deteriorate. In addition, worker outcomes may be different following buyouts by domestic and foreign firms, as shown in Olsson and Tåg (2018). Moreover, Faccio and Hsu (2017) document a different source of heterogeneity. The authors find greater job growth, on average, at establishments operated by targets of politically connected private equity firms, results which are consistent with connected private equity firms and politicians trading favors. Besides documenting impacts on net employment at the firm level, several papers have investigated the career-path implications for workers at firms that get bought by private eq- 11 Electronic copy available at: https://ssrn.com/abstract=4214664 uity firms as well as within-firm variation in the implications of private equity ownership for employees. Antoni et al. (2019) document worse employment losses among white-collar em- ployees and greater earnings losses among managers and older employees. The authors argue that these employees struggle to find similar wages at other firms. Olsson and Tåg (2017) also explore within-firm heterogeneity but through the lens of routine-biased technological change. Entrenched managers may be reluctant to adopt NPV-positive investment if it would also result in layoffs. New private equity owners, with no ties to the current employees, are more likely to make such investments. Using Swedish data, the authors find results consistent with these arguments. Workers in occupations that perform either routine or offshorable tasks realize higher rates of unemployment following a buyout. While technology can replace workers engaged in routine tasks, it has been shown to be complementary to high-skill workers, a topic explored in Agrawal and Tambe (2016). Consistent with the argument of heterogeneous impacts, Agrawal and Tambe (2016) show positive effects of private equity investment on employees who perform IT-related tasks. Using proprietary data from an online job search platform, the authors document higher employability and higher wages among workers employed at firms with private equity owners. Private equity firms adopt more technology and employees at these firms gain transferable skills which improves their future job opportunities. Finally, Fang et al. (2021) look at the impact of private equity investments on pay gaps within the firm. Using French data, the authors document a shrinking of the 90/10 wage ratio, the gender pay gap, as well as the difference in mean wages between younger and older employees following a private equity buyout. These results suggest that private equity owners can increase firm value by cutting the rents earned by high-wage employees. Employment risk and compensation are not the only margins on which a buyout might affect worker well-being. Cohn et al. (2021) find that OSHA safety violations and workplace injury rates decline following a private equity buyout, suggesting that employees benefit from improved workplace safety. Alternatively, Gornall et al. (2021) use employee review data to show that private equity buyouts reduce perceived job quality, presumably by raising the chances of firm distress. They also find that PE-owned firms use incentive pay to pass returns through to 12 Electronic copy available at: https://ssrn.com/abstract=4214664 employees and do so to a greater extent than publicly traded firms. Finally, Garcia-Gomez et al. (2020) look at a possible impact of PE buyouts on employees’ health. Using Dutch data, they find no evidence of worsening employee health post-buyouts. However, they note that ex-ante poor health is a predictor of job losses following the private equity buyout. In a complementary study, Gupta et al. (2021) find that PE ownership of nursing homes increases short-term mortality of Medicare patients, a result driven, in part, by lower staffing post-buyout. Overall, despite the comparatively positive empirical evidence, the role of PE funds has been controversially discussed among policy makers and public opinion is often negative.2 As with M&As, there seem to be winners and losers. Over-paid employees or employees in poor health appear to be more likely to lose their jobs as in Fang et al. (2021) and Garcia-Gomez et al. (2020), respectively. Likewise, employees engaged in tasks that can be replaced by technology or lower-cost offshore labor are also more at risk of losing their jobs under private equity ownership, as in Olsson and Tåg (2017). Alternatively, the deeper pockets of private equity owners can facilitate investment which reduces workplace injuries, as in Cohn et al. (2021) or investments in technology which has positive spillover effects on employees engaged in IT-related tasks, as in Agrawal and Tambe (2016). 2.4 Privatization Privatization, namely the act of a government transferring control rights to private entities has become increasingly common. In the context of labor, there is a natural question as to the likely impact of privatization on the incumbent employees. Surprisingly, there is little empirical evidence on this question. Using employee-employer matched administrative data from Sweden, Olsson and Tåg (2021) investigate the career impacts on workers at state-owned enterprises which privatize. State ownership can be used to achieve political goals, such as lower unemployment. As such, new private owners may engage in a significant reorganization of employees once they take control. Consistent with this argument, the authors find that wages 2 In a related stream of the literature, Brav et al. (2015) shows that hedge fund activism is associated with higher labor productivity but no significant changes in hours worked. 13 Electronic copy available at: https://ssrn.com/abstract=4214664 drop, on average, following a privatization, but recover after eight years. Moreover, there is an immediate increase in unemployment among workers at privatized firms and this change is permanent. These negative effects are concentrated among unskilled and older employees. 2.5 Family Firms Family ownership is common in many developed countries (La Porta and Shleifer (1999)). Specifically, Anderson and Reeb (2003) report that one third of the firms in the S&P 500 are family-owned. Working at a family-owned firm may have implications for employees given pressures to promote family members to leadership roles as well as the fact that family firms often have a long-term focus around legacy. However, this preference for legacy can also re- solve a commitment issue which otherwise prevents firms from providing greater employment guarantees to their workers (Ellul et al. (2018)). Sraer and Thesmar (2007), Bassanini et al. (2013), and Ellul et al. (2018) show that family firms offer greater job security. To establish causality, Ellul et al. (2018) use variation in government policies to assist unemployed workers, laws and regulations that will shift the demand for greater employment guarantees by labor. The authors find that family firms provide greater employment stability, albeit with a wage discount, when unemployment insurance is less generous. 3 Capital Structure, Distress and Labor Since its early days, the labor and finance literature has paid considerable attention to the interaction between labor and leverage. Several papers have studied how firms’ optimal capital structure decisions are impacted in the presence of labor market frictions. That literature has identified two distinct channels: i) firms can use debt strategically in the presence of strong unions to achieve better outcomes on the negotiation table; ii) rigid labor claims, which can resemble debt claims, create operating leverage crowding out financial leverage. A related liter- ature studies how access to credit impacts firms’ labor decisions and implications for employees. The consensus in that literature is that firms’ limited access to credit, either due to firms-specific 14 Electronic copy available at: https://ssrn.com/abstract=4214664 or to economy-wide shocks, has large negative effects on their ability to attract and retain key talent and, more broadly, on their overall employment and wages. 3.1 The Relationship Between Labor and Debt The early literature on labor and finance has focused on the relationship between labor and debt. Key topics in this literature concern the role of unions or other types of labor protections in determining firms’ capital structure decisions as well as the interaction between employee wages and leverage. Matsa (2018) and Pagano et al. (2020) discuss in detail this literature in excellent review articles. Important theoretical work by Bronars and Deere (1991), Perotti and Spier (1993), and Dasgupta and Sengupta (1993) focuses on the strategic use of leverage in the presence of labor unions. The key intuition in these papers relates to the fact that firms will strategically take on debt to lower the bargaining power of labor (and other suppliers of input), achieve wage concessions and reduce underinvestment related to hold up problems caused by labor. Matsa (2010) provides robust empirical evidence that firms indeed use debt strategically in the presence of powerful labor unions. Using the staggered adoption of state legislation in the U.S., which changed the relative power of labor unions, Matsa (2010) finds robust evidence for this channel, especially at firms with higher levels of corporate liquidity which can encourage higher wage demands. The literature has also examined the relationship between employment protection regu- lations and firm leverage. Unlike unions, which actively negotiate with firms on wages and therefore directly impact corporate liquidity, employment protection legislation impacts finan- cial leverage through an operating leverage channel. Such regulation makes labor costs more rigid, crowding out financial leverage. In other words, operating leverage, created by rigid la- bor claims, and financial leverage act as substitutes. This operating leverage channel via which labor impacts firms’ debt was first documented by Simintzi et al. (2014). The authors focus on pro-labor employment legislation in 21 OECD economies that protects employees from layoffs, 15 Electronic copy available at: https://ssrn.com/abstract=4214664 thereby increasing firms’ restructuring costs and their cost of financial distress for a given level of debt. It has later also been documented by Serfling (2016) in the context of the United States. Through a structural model, Favilukis et al. (2020) study general equilibrium effects with heterogeneous firms using long-term wage and debt contracts to understand how labor market frictions impact credit risk and capital structure. The key takeaway from their model is that rigid labor markets make debt riskier, negatively affecting credit markets and impacting the price as well as the quantity of leverage. Using both aggregate and firm-level data in the U.S., they find empirical support for their model’s implications. Ellul and Pagano (2019) argue that the relation between labor and leverage depends on the relative seniority of labor and creditor claims in bankruptcy. Collecting information on the relative seniority of claims in bankruptcy in 29 countries, they show that there is substantial cross-country variation in terms of how labor fares in bankruptcy vis-a-vis other creditors. They also emphasize the role of financial constraints: the strategic debt channel is more pronounced when firms are below their optimal debt capacity and can thus take on debt strategically to achieve wage concessions with labor. Specifically, they show that financially unconstrained firms increase debt when they experience rises in corporate property values or profitability in countries where employees have strong seniority in liquidation. The prediction is the opposite for firms that face binding financial constraints. More generally, the literature has shown that firms follow relatively more conservative fi- nancial policies when they face higher labor adjustment costs (Ghaly et al. (2017); Cui et al. (2018); Karpuz et al. (2020)), especially if they are small or financially constrained (Schmalz (2018)). And conversely, firms better positioned to substitute labor with automation, thereby reducing labor-induced operating leverage, maintain lower cash levels and higher leverage as they can support relatively less conservative financial policies as in Bates et al. (2020). The negative relationship between firm leverage and labor can also operate via an employee- firm risk sharing channel. In seminal work, Berk et al. (2010) model a competitive labor market and argue the optimal debt contract results from firms trading off the tax benefits of debt with the human capital costs of bankruptcy. This paper started an empirical literature testing 16 Electronic copy available at: https://ssrn.com/abstract=4214664 this theoretical relationship. Agrawal and Matsa (2013) find that increases in state-mandated unemployment benefits, which reduce unemployment costs borne by labor, lead to increases in corporate leverage. Kim (2020) shows that an increase in the size of the local labor market, which reduces workers’ cost of job loss (or improves employee-firm risk-sharing) ex-ante, leads to an increase in leverage for local incumbent firms. Berk et al. (2010) also argue that in the cross-section, risk-averse employees who incur large human capital costs of bankruptcy, will accept lower wages in return for employment insurance, predicting a positive relation between firm leverage and wages. Consistent with this model’s predictions, several papers have documented a positive and significant correlation between leverage and average employee pay as in Chemmanur et al. (2013) and Akyol and Verwijmeren (2013). In related work, Bae et al. (2011) and Verwijmeren and Derwall (2010) find a negative relationship between KLD’s Employment Treatment Index (an index capturing ratings given to firms in relation to their employee treatment standards, compiled by KLD Research & Analytics, Inc.) and firm leverage. Similar to better wages, firms with more employee-friendly policies, on average, maintain lower debt ratios, and are also likely to hold more cash (Ghaly et al. (2015)). In contrast, Michaels et al. (2019), using detailed data that link establishment-level employee earnings and firm leverage, document a negative relation between leverage and average establishment-level labor earnings. 3.2 Financial Distress and Employment Another important strand of the literature focuses on how leverage, and especially financial distress, impacts employment and wages. Similar to the literature on financial constraints and capital, financial constraints should have a negative impact on employment. Benmelech et al. (2021) show a causal link between financial constraints and access to credit and firm employment. Caggese et al. (2019) further show that financially constrained firms fire short- tenured workers with high skills and more positive productivity growth prospects, leading to a misallocation of human capital. Michaels et al. (2019) establish a negative relationship between leverage and average establishment-level labor earnings, both in the cross-section and over time, 17 Electronic copy available at: https://ssrn.com/abstract=4214664 using data that link establishment-level employee earnings and firm leverage. These results are in line with early empirical evidence (such as Hanka (1998); Kang and Shivdasani (1997)) that constrained firms, with high levels of debt, are more likely to lay-off employees, use part-time workers, and pay lower wages. The negative relationship between leverage and employment or earnings seems to be espe- cially pronounced in the event of firm-specific credit market failures. For instance, Agrawal and Matsa (2013) look at bond defaults by firms and show that such firms cut employment by about 30% in a year. Similarly, Falato and Liang (2016) find that firms reduce their labor force substantially after loan covenant violations, and Hotchkiss (1995) shows that firms undergo employment reductions around Chapter 11 bankruptcy filings. Using employee-firm matched administrative data in the U.S., Graham et al. (2022) document large labor income losses for employees after their firm files for bankruptcy. The earning losses are not confined to the year of bankruptcy but extend for several years after the event. The cost to compensate for the expected earnings losses that follow corporate bankruptcy is substantial and amounts to 1% (3%) of firm value for an AA-rated (BBB-rated) firm, relative to a risk-free firm. Financial distress not only forces firms to restructure labor but it is also associated with loss of valuable talent to the firm. Firms that enter financial distress lose talented employees who seek employment elsewhere. Baghai et al. (2021) show that high-skilled workers are more likely to leave firms in financial distress, using Swedish data. Babina (2020) documents a similar finding in the U.S., showing financial distress is positively associated with employee departures to entrepreneurship. Such departures negatively impact the firm’s bottom line. Focusing on outcomes related to innovation, Baghai et al. (2019) show that bankruptcies disrupt teams and lower productivity due to the loss of important team-specific human capital. They also show that inventors who value collaborations are more likely to move to the same firm with their team members after bankruptcy, and these inventors also tend to innovate more after relocation. In addition to retaining employees, financial distress can also make it difficult for firms to attract top talent. To this end, Brown and Matsa (2016) use data from an online job search platform and find that increases in employers’ financial distress is negatively associated 18 Electronic copy available at: https://ssrn.com/abstract=4214664 with the quantity and quality of received job applications during the 2008 financial crisis. Similarly, Gortmaker et al. (2020) show that incumbent firm workers tend to expand their network connections on LinkedIn, a professional networking and career development platform, when working at firms experiencing credit deterioration even when these firms are far from bankruptcy. 3.2.1 Economy-wide Recessions and Employment The contraction of employment due to limited credit supply has been observed following big economic downturns. There is consensus in the literature that economic crises are followed by a large reduction in employment via two related channels. The first channel relates to the disruption of credit supply to firms. In that regard, Benmelech et al. (2019) show that financially constrained firms that were unable to raise capital during the Great Depression of 1929-1933 were the ones that experienced the largest reductions in employment. This channel is viewed to be principally responsible for aggregate decline in employment during the Great Depression. The same channel was at work during the more recent 2008 financial crisis with credit constrained firms experiencing the largest declines in employment, as shown in Chodorow- Reich (2014). Survey evidence presented by Campello et al. (2010) complement these empirical findings showing that financially constrained firms were forced to curtail their employment and planned capital expenditures during the financial crisis. The second channel relates to the firms’ balance sheets. Giroud and Mueller (2017) high- light that besides intermediaries’ financial health, firms’ financial health was also consequential in explaining the employment reduction following the 2008 financial crisis. They show that establishments of more highly levered firms in the run up to the financial crisis saw greater reductions in employment during the crisis. Acabbi et al. (2020) also show, in the context of Portugal, that firms with higher operating leverage before the crisis suffered disproportionately more. More recently, several articles have focused on how the Covid-19 pandemic and subsequent government policies designed to sustain labor supply have impacted firms’ employment out- 19 Electronic copy available at: https://ssrn.com/abstract=4214664 comes. Specifically, several papers studied the Paycheck Protection Program (PPP), a part of the initial policy response to Covid-19 in the U.S., designed to support small businesses. The PPP was primarily intended to provide liquidity to small firms to help them avoid lay- offs and maintain payroll during the pandemic. Autor et al. (2022) and Hubbard and Strain (2020) report evidence of a modest impact of PPP on employment at small businesses. They use difference-in-difference estimates exploiting the program’s threshold for eligibility as well as whether a small business actually applied for a PPP loan. Granja et al. (2022) use a design that exploits differences in the performance of banks across regions. Their findings are there- fore more generalizable to the population of eligible firms as their estimates are not local to the threshold region. They find negligible employment effects in the first month of the program, but modest positive effects over the next few months. The paper estimates the cost per job saved by the PPP to be $175,000, similar to those of Autor et al. (2022). In contrast, Faulkender et al. (2020) document a stronger positive employment effect of the PPP program. Most of these studies use survey-based data that typically have limited coverage. To this end, Chetty et al. (2020) use anonymized data from private companies to create a novel database capturing high-frequency employment, consumer spending, and other measures. Using this data, they estimate that the PPP had a modest positive impact on maintaining employment levels at impacted firms. Moreover, they notice interesting heterogeneity in the impact of the crisis on low-wage and high-wage workers as well as on firms in the most and least affluent areas. They find that employment rates fell significantly more among workers in the bottom quartile of the pre-COVID wage distribution when compared to those in the top quartile. Employment loss among low-wage workers were also more persistent. In addition, they report that layoffs were substantially higher, and job postings significantly lower, for small firms in the most affluent ZIP codes, as compared to the least affluent ZIP codes. Although most papers focus on the impact of Covid-19 on labor demand by firms, Bernstein et al. (2020) use high-frequency job search data from an online platform around the Covid-19 pandemic to document how the pandemic impacted labor supply. Specifically, they observe a shift of job seekers towards “safety” in light of increased uncertainty during the crisis. They 20 Electronic copy available at: https://ssrn.com/abstract=4214664 show that job applicants alter their search parameters towards more established firms and away from early-stage startups - an effect that persists even within the same individual over time. Subsequently, early-stage firms find it harder to attract candidates and experience a sharp decline in the quantity and quality of job applications. 4 Firms and Inequality While the labor and finance literature has initially focused on how firms’ external providers of capital interact with firm-level labor outcomes, as discussed in the previous sections of this article, there is increasing interest by financial economists in understanding the structure of pay within and across firms. This literature has been motivated by a better understanding that firms’ human capital is a key intangible asset to the success of the firm (Edmans (2011)) and that the relative pay of firms’ workers can have important implications for the value of the firm. This literature has further been motivated by a renewed interest amongst economists in the growing macro trends of increasing inequality, as discussed by Piketty and Saez (2003). An important construct relied on in this literature is to decompose aggregate wage variance t be the wage for employee i at into within- and between-firm components. Specifically, let bi,f firm f at time t. This can be separated into two components: bi,f f i,f f t = b̄t + [bt − b̄t ] (1) Where b̄ft is the average wage for firm f at time t. It thus follows that the overall variance can be decomposed into two components: var(bi,f f i,f t ) = varf (b̄t ) + Σf ωf x varj (bt |i ∈ f ) (2) Where the first term captures between-firm dispersion of wages and the second term captures the employment-weighted mean of within-firm dispersion in wages. ωf is the employment share 21 Electronic copy available at: https://ssrn.com/abstract=4214664 of firm f in the sample. Pay disparities within a firm can be concerning to investors to the extent that they reflect the ability of high-paid individuals to extract rents. In addition, within-firm pay disparities may distort employee effort, as in Cullen and Perez-Truglia (2022), and lead to higher quit rates, as in Dube et al. (2018). While within-firm inequality is a concern, Breza et al. (2018) show that when dispersion in wages can be tied to differences in worker productivity, there is no discernible impact on output, attendance, or group cohesion. Instead, it is unjustified horizontal pay inequality, namely wage differences that cannot be attributed to differences in productivity, rather than absolute pay inequality, that negatively impacts employee effort. Moreover Cullen and Perez-Truglia (2022) show that positive shocks to employee perceptions of their manager’s wages can lead to an increase in worker productivity, consistent with career concerns. Although, any effects on both worker productivity and public perception are likely to be highly dependent upon specific norms and prevailing cultural attitudes. In response to rising concerns about firm inequality, policymakers have taken action. As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, public companies listed in the U.S. are now required to disclose the pay ratio between the median employee and the CEO. Pan et al. (2022) find negative abnormal returns upon disclosure of high CEO-worker pay ratios, suggesting investors dislike the inequality measured by that pay ratio. Interestingly, LaViers et al. (2022) find that investors respond positively to voluntary disclosures of CEO pay ratios which tend to be accompanied with more firm-specific information. Investors may respond more positively to voluntary firm-specific disclosures if they provide more explanation, especially for firms with high CEO pay ratios. Managers also appear to dislike internal wage inequality. Silva (2021) finds that events that increase wages in one part of a firm (e.g. a local minimum wage increase) increase wages in other parts of the firm. The paper shows that this effect is strongest in unionized firms and is weaker in firms in more competitive markets. Such concerns, may not, however, be necessarily warranted if firm pay inequality reflects managerial talent. Gabaix and Landier (2008), for example, argue that CEO pay is higher in larger firms, reflecting an optimal matching equilibrium where more talented CEOs are 22 Electronic copy available at: https://ssrn.com/abstract=4214664 matched to larger firms. Consistent with this theory, Mueller et al. (2017) use a proprietary dataset from the U.K. in which wages are observed at the hierarchy-firm-year level, allowing for inferences across firms. Consistent with the idea that more talented managers match with larger firms and employees are paid according to their marginal product, they find that within-firm pay inequality increases with firm size. In further support for this argument, they find firms with higher pay inequality have larger valuation and stronger operating performance. Faleye et al. (2013) construct ratios of CEO pay (from ExecuComp) to average employee pay (from Compustat) and also find a positive association between pay inequality and firm performance. There are other theoretical justifications which can justify high pay inequality. For example, Edmans et al. (2011) model a firm where employees exert synergies on each other and show that high pay ratios may be justified in equilibrium to incentivize synergistic employees who have large positive spillover effects on others. Song et al. (2019) use Social Security Administration masterfile wage data to show that within-firm variance is higher, relative to between-firm variance, but that between-firm variance has increased more over the past thirty years. In fact, two-thirds of the increase in the overall variance in wages can be attributed to growing between-firm variance in wages. Barth et al. (2016) document a similar pattern at the establishment-level using Census data. Interestingly, this increasing between-firm variance in wages is not driven by differences in compensation practices across firms as much as driven by changes in the composition of workers. As shown in Song et al. (2019), there has been an increase in worker sorting, defined as high-wage workers being more likely to work at high-wage firms, and an increase in worker segregation, defined as high-wage workers being more likely to work with each other. Ownership appears to be an important driver of within-firm inequality. Several papers have looked at the implications of shocks to ownership. Ma et al. (2016) find that post- M&A, the standard deviation in establishment wages increases by 4%, as compared to a control establishment, consistent with an increase in reliance on technology post-M&A which acts as a substitute for low-skill labor and a complement for high-skill labor. On the other hand, Fang et al. (2021) find that following a private equity buyout, the pay gaps between the 90th and the 23 Electronic copy available at: https://ssrn.com/abstract=4214664 10th percentile of wages shrinks by 2.2%. This effect appears to be associated with increased departures among high wage workers following the private equity investment. Bena et al. (2022) find that firms owned by immigrants from countries where individualism is emphasized more than group harmony pay more unequal wages. Besides ownership, managerial practices impact workers’ pay and thereby have implications for inequality. Entrenched managers, who are better protected from negative consequences following poor performance, pay their workers more, as in Bertrand and Mullainathan (1999); Bertrand and Schoar (2003) and Cronqvist et al. (2009). Acemoglu et al. (2022) show that after firms appoint a manager with a business degree, wages decline, with more negative effects for low-skilled workers, as compared to high-skilled workers. The papers reviewed so far have focused exclusively on wages even though non-wage benefits now contribute approximately 30% of total compensation (Bureau of Labor Statistics (2021)) and have implications for long-run stock returns (Edmans (2011)). Data availability has limited research in this area to date. Ouimet and Tate (2022) merge data from the Bureau of Labor Statistics (BLS) National Compensation Survey (NCS) with the Census Longitudinal Business Database (LBD) and Longitudinal Employer Household Dynamics (LEHD) programs. The authors show that there is less within-firm variation in health and retirement benefits, as com- pared to wages. This finding is likely driven by regulations which limit the ability of firms to discriminate in their provision of benefits within the firm. They also show that there is larger between-firm variation in benefits, as compared to wages. These findings have important real implications; Firms with more generous non-wage benefits reduce their reliance on low-wage workers more than their low-benefit peers. Preferences for firm attributes can also influence inequality. Krueger et al. (2020) document lower wages at firms in more sustainable indus- tries, especially for high-skill workers. Their results suggest that workers are willing to forgo some compensation to work for more socially beneficial firms. Moreover, given this sustain- ability wage gap is more pronounced among high-skill workers, this also has implications for inequality. An important strand of the literature also aims to understand the drivers and effects of 24 Electronic copy available at: https://ssrn.com/abstract=4214664 the higher wages typically found in finance, as compared to other industries (Goldin and Katz (2010); Philippon and Reshef (2012)). Philippon and Reshef (2012) and Ellul et al. (2020) show that wages are higher in finance even after adjusting for career risk. Kaplan and Rauh (2013) and Bell and Van Reenen (2013) argue that the high compensation of workers in finance is a large contributor to the rise in overall top income inequality. Higher wages in finance have been attributed to higher returns to talent, which result from competition for a limited pool of talent and talent-scale complementarities (Célérier and Vallée (2019)), moral hazard, which makes it optimal for firms to incentivize workers with higher pay within the finance profession (Axelson and Bond (2015)), or higher rent sharing (Böhm et al. (2022)). Moreover, competition for workers has negative externalities on financial stability (Thanassoulis (2012)), efficiency and risk-sharing (Acharya et al. (2016)), work ethics (Bénabou and Tirole (2016)), and talent allocation (Glode and Lowery (2016)). Understanding the source of the finance wage premium can meaningfully inform regulation, as well as policy targeted towards reducing overall earnings inequality. 4.1 Firms and Gender Pay Disparities Another important aspect of inequality is across genders and a growing body of research high- lights the role of firm-specific differences in contributing to gender pay inequality (e.g., Tate and Yang (2015a); Card et al. (2016); Sorkin (2017)). Tate and Yang (2015a) highlight the role of female leadership in promoting gender equity by showing that pay penalties incurred by workers following plant closures are higher for women - but this effect is moderated if the hiring firm has female leadership. Card et al. (2016) show that firm-specific differences explain roughly 20% of the gender wage gap in Portugal. Several firms have been taking action towards reducing gender disparities. For example, Liu et al. (2022), using crowd-sourced employee reviews of benefits from Glassdoor, show that firms use generous maternity benefits to increase gender diversity, particularly in labor markets where female talent is scarce. Given gender pay inequality is partly due to the fact that there are few women at the top, attracting female talent may have implications for reducing 25 Electronic copy available at: https://ssrn.com/abstract=4214664 gender pay disparities at the firm. Several countries have also responded to this pressing issue by passing transparency legislation that requires firms to disclose gender dis-aggregated data. Bennedsen et al. (2022) study the effects of such a mandated disclosure regulation in Denmark. Using detailed employee-firm administrative data and both a difference-in-differences and a difference-in-discontinuities approach, they find that pay transparency is successful in narrowing the gender pay gap by 13%, relative to the pre-legislation mean. Interestingly, the law leads to lower wage growth for men while female wage growth does not change significantly. The law also had unintended consequences on other margins associated with female employment, including fewer departures and higher hiring and promotion rates. In contrast to the view that such policies are costly to firms, Bennedsen et al. (2022) find that firm performance remains unchanged. Lagaras et al. (2022) also investigate a pay transparency regulation and find that it led to more equal outcomes in the financial sector. The authors study a recent regulation in the U.K. which requires companies with more than 250 employees to publish information about the differences in pay between men and women on a government website. Pay disclosure impacted the financial sector specifically in the U.K., as the finance industry is characterized by larger gender pay gaps relatively to the rest of the private sectors and because media targeted the financial sector by ‘naming and shaming’ firms with high gender pay disparities. Lagaras et al. (2022) also study the determinants of this higher gender pay gap in the financial sector and provide evidence consistent with a sorting explanation where talented women are less likely to work in finance due to higher costs associated with working in the sector for female talent. In contrast, legislation that decreases information by banning employers from asking po- tential employees about past salaries has had more nuanced wage implications. Salary history bans have been justified as a means to reduce the gender pay gap by severing the link between current wages and historical pay discrimination. Using a sample of public sector employees, Davis et al. (2021a) find that salary history bans reduce the gender pay gap, but only within a subset of occupations where employees are most likely to have faced historical discrimination. Hansen and McNichols (2020), using the Current Population Survey (CPS), find similar results, 26 Electronic copy available at: https://ssrn.com/abstract=4214664 documenting no change in the gender pay gap for the full population but a decrease in the gen- der pay gap among women over 35 and women with children. Importantly, salary history bans also increase an employer’s uncertainty about a worker’s productivity, which in the presence of labor market protections, should lead to lower wages. Consistent with this prediction, Davis et al. (2021a) find that wages for public sector new hires declines by 3% following the adoption of a salary history ban. Likewise, Sran et al. (2020), using a sample of online job postings, find a significant decrease in average wages following a salary history ban, which the authors attribute to adverse selection as high-wage employees are less likely to seek a new job after the enactment of a salary history ban. This literature has also explored differences in career progression by gender more broadly. Women face additional barriers and often discrimination in the workplace. Consistent with this, female financial advisers are more likely to face harsher outcomes following misconduct (Egan et al. (2019)), female division managers are allocated less capital relative to men (Duchin et al. (2021)), and women are less likely to receive equal pay or get promoted in sectors or firms with male-dominated cultures (Tate and Yang (2015a); Adams et al. (2018); Hospido et al. (2019)). Finally, women are also more likely to receive lower potential ratings relative to their actual job performance, suggesting that firms persistently underestimate the potential of their female employees (Benson et al. (2021)). 5 Technology Adoption, Labor and Firm Outcomes To study the role of firms in explaining pay inequality, it is important to discuss the firm-level determinants of technological adoption given the well understood role of technological change in explaining labor outcomes (Autor and Dorn (2013); Kogan et al. (2022)). In response, a new literature in corporate finance has emerged to better understand the drivers of technology adoption at the firm-level and to document micro-level evidence regarding how technology impacts firm-level labor outcomes. 27 Electronic copy available at: https://ssrn.com/abstract=4214664 5.1 Drivers of Technology Adoption: Firm-level Evidence It is rather intuitive that firms should invest in labor-saving technology (embedded in capital goods) when the price of labor relative to capital makes it more cost effective for them to adopt such technology. A new set of papers discuss several specific frictions which show how increases in the relative price of inputs of production drive firms’ decision to adopt technology. Bena and Simintzi (2019) show that firms’ decisions to invest in technology depends on access to cheap offshore labor. In other words, U.S. firms have two substitutes for relatively more expensive U.S. labor: cheap offshore labor or greater adoption of technology. Once one substitute becomes more attractive, the return on investment in the other substitute dimin- ishes. In their paper, they focus specifically on labor-saving innovation (process innovation) and develop a new measure likely to capture novel ideas that allow firms to lower production costs and adjust their production processes to rely less on labor. Their finding lends empiri- cal support to the theoretical intuition provided by Jones (2005) who argues that firms need to change their production processes and operate at higher capital-labor ratios to invent new production techniques. In addition, regulations may also change the relative price of labor and capital. For example, several countries have adopted laws to protect labor from dismissal, which increases labor adjustment costs for firms and therefore the relative price of labor and capital. This regulation- induced change, which has been shown to increase operational leverage and hurt firm value, should also prompt firms to replace labor with capital. Bena et al. (2021) study state-level legal changes in the U.S. which limit firms’ ability to fire workers. The authors show that firms with a higher ability to patent produce labor-saving innovation in response to these regulations and change their production processes to become more capital intensive, thus, mitigating value losses due to higher labor adjustment costs. Focusing on a different regulation, Dai and Qiu (2022) also arrive at a similar conclusion. They study state-level changes in minimum wages and show that establishments increase investments in IT following a hike in minimum wage. In a similar vein, Hau et al. (2020) utilize heterogeneous changes in minimum wages across 28 Electronic copy available at: https://ssrn.com/abstract=4214664 counties in China to study firms’ capital-labor substitution response. They find that low-wage firms have larger labor to capital substitution relative to their high-wage industry peers, and this larger substitution is accompanied by productivity improvements. In contrast, Gustafson and Kotter (2022) study federally mandated changes in state-level wages in the U.S. and find that increasing wages decrease total capital investment among exposed firms in minimum wage sensitive industries. Another shock to labor has been the opioid epidemic, which is responsible for over 80,000 deaths in the U.S. in 2021 and countless more lives ruined through addiction. Ouimet et al. (2020) show that the unprecedented opioid epidemic in the U.S. has negatively impacted labor supply in the affected areas. This deterioration in the quantity and quality of labor supply has pushed firms to adopt technology and lessen their dependence on labor. This capital deepening process has negative implications for local communities, as it suggests that certain types of jobs, previously done by those mostly impacted, will be permanently lost in those labor markets. Tax-policy has also been shown to be a driver of technological adoption. Tuzel and Zhang (2021) show that tax incentives that allow for a faster depreciation of equipment led firms to invest more in technology and high-skilled labor. Moreover, these firms shed workers engaged in high-routine tasks, consistent with labor substitution. An important innovation in this paper is showing the shift in the skill demand by firms, which may not be visible when looking at aggregate employment such as in Ohrn (2019). Mao and Wang (2022) highlight how access to finance can interact with labor practices driving technological advancement. Focusing on a historical episode from pre-Civil War America, they show that the ease of financing incentivized a substitution of labor only for producers without access to enslaved laborers. In contrast, increased availability of mortgages and equity loans also enabled the financing of slavery and made producers with access to enslaved laborers less likely to shift away from labor-intensive production methods. Finally, several papers have looked at the drivers of robot adoption, which tends to replace low-skill employees at firms. Looking at the microeconomic implications of robot adoption, Koch et al. (2021) document that robot adoption among Spanish manufacturing firms is less 29 Electronic copy available at: https://ssrn.com/abstract=4214664 prevalent among skill-intensive firms, as gains from automation is negatively associated with skill intensity. At the same time, there is a positive selection effect in robot adoption: firms with better productivity are more likely to adopt robots. Benmelech and Zator (2022) show that adoption of automation technologies in general, and robots in particular, varies significantly across industries. Investments in these advanced technologies are shown to be concentrated within a few manufacturing industries, such as the automotive sector, with modest adoption in other manufacturing industries and minimal adoption in non-manufacturing sectors. Overall, the authors comment that the trend in robot adoption does not resemble the explosive growth observed for IT technologies. 5.2 How Technology Affects Firm Labor Outcomes The adoption of technology changes the composition of labor within firms, as well as the tasks assigned to employees, with implications for wages. It is well documented that technology adoption is routine-biased, in aggregate, lowering demand for skills that are repetitive and easily replaceable by machines. At the same time, technology is skill-biased, increasing demand for high-skill employees (Autor and Dorn (2013); Katz et al. (1999); Autor et al. (2003)). Such employment changes should increase wage inequality within firms, mirroring the macro trends. Indeed, Ma et al. (2016) find that takeover-induced technology adoption changes employ- ment composition at target firms, replacing routine occupations and increasing demand for high-skill occupations thereby increasing pay inequality at the target firm. Similarly, Lagaras (2017) provides evidence of post-M&A labor restructuring consistent with technology adop- tion in the context of Brazil. Olsson and Tåg (2017) and Agrawal and Tambe (2016) provide evidence of skill upgrading following private equity buyouts which then has implications for both firm productivity and the workers involved. Barth et al. (2022) further examine possible effects of technology adoption on worker earnings. They find that high-wage workers gain more from greater technology adoption relative to low-wage workers and, similarly, high-wage firms benefit more relative to low-wage firms. The findings from these papers suggest that technology adoption may exacerbate wage inequality within and across firms. However, technology can 30 Electronic copy available at: https://ssrn.com/abstract=4214664 also increase the risk of obsolescence. As innovation displaces earlier technology, this exposes workers, especially those at the top of the income distribution (Kogan et al. (2021)). Own firm innovation is followed by an increase in both the mean and variance in worker earnings growth. In contrast, innovation by competing firms is correlated with lower, and more negatively skewed, future earnings. In recent important work, Kogan et al. (2022) provide time-series evidence of how exposure to technological innovation, as measured by patents, impacts labor outcomes. They follow Kelly et al. (2021) to identify novel and important patents and compute the similarity between those patents and occupation job descriptions to create a measure of workers’ exposure to technological change over time. A higher rate of innovation is associated with worse worker- level labor market outcomes. Interestingly, they find that earnings of older and highly-paid workers are particularly sensitive to this technology exposure. The authors argue that this is not at odds with the traditional model of capital-labor complementarity but instead suggests a more nuanced understanding of the relationship by allowing for skill displacement. With new technological advances, skills of some incumbent high-skill workers become increasingly obsolete, translating into negative labor market outcomes for these workers. In addition, a few papers have focused specifically on new technological waves, such as big- data, Artificial Intelligence (AI), and FinTech, and how they have influenced employment at firms. Babina et al. (2022) look closely at worker composition following AI-adoption and find major changes in labor composition and organization. They show that AI-adoption induces a shift towards a younger and more educated workforce. AI-investing firms hire more employees with STEM degrees and skills in data analysis and IT and these firms also experience an increase in the share of junior employees, subsequently turning less top-heavy in terms of their organizational structure. Relatedly, Alekseeva et al. (2021) document a within-firm wage premium associated with jobs requiring AI-related skills, even within the same job title. In the context of the Financial Services industry, Jiang et al. (2021) suggest that the FinTech disruption also seems to have prompted firms to adopt an upskilling recruiting strategy. They show that FinTech-exposed firms tend to hire more educated and experienced employees with 31 Electronic copy available at: https://ssrn.com/abstract=4214664 specific skills in both finance and IT. 6 Implications for Future Research The study of the interactions between labor markets and firms and the mechanisms that dictate them has become an increasingly important topic in the corporate finance literature. There are at least three reasons that have contributed to the large production of ideas in the field. First, while the importance of labor market trends has been a key topic of study in the eco- nomics literature, less has been known about the role of firms providing the corporate finance profession a unique opportunity to ask interesting and novel questions; second, new data has become increasingly available allowing this field to flourish; third, there has been a renewed view among shareholders and policymakers about the objective of firms with a specific emphasis on stakeholders, with labor being arguably at the epicenter of this discussion. It is also noteworthy that the field has expanded fast trying to explain contemporaneous trends and give answers to policy relevant questions that deeply impact society. The literature on firm-level disparities is a stellar example of that feedback loop between what research can teach us and how the world operates. And this dynamic relationship keeps feeding researchers with new interesting questions to study. So, where does the labor and finance field go from here? Our perspective is that there are at least three areas that appear ripe for more work. Firms and racial diversity is certainly one of them. While the literature has made advances in terms of understanding the role of gender, race has been generally overlooked. Second, there is an interesting new field emerging looking at worker health and finance. The recent COVID19 pandemic has certainly highlighted the intertwined relationship between firms and worker health. Furthermore, additional work needs to be done exploring the impact of ESG investing on the relationship between firms and workers with a specific emphasis on the "S" or social objectives. 32 Electronic copy available at: https://ssrn.com/abstract=4214664 References Acabbi, E. M., E. Panetti, and A. Sforza 2020. The financial channels of labor rigidities: Evidence from portugal. Working Paper. Acemoglu, D., A. He, and D. le Maire. 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