Pietro Garibaldi

“Labor and Finance: Mortensen and Pissarides meet Holmstrom and Tirole”

abstract

In real life labor markets firms hold at all times a variety of liquid assets not invested in their core business. Such external use of funds acts as an insurance against future adverse financial shocks, and typically varies across firms and sectors. As a result, di erent rms use di erent degrees of nancial leverage. This paper investigates the consequence of firms’ use of funds on their hiring and firing policy. Using a standard matching model of unemployment, the paper finds an equilibrium interplay between labor market imperfections and financial market imperfections. We show that financial market imperfections- such as the probability of refinancing or firms’ share of their pleadgeable income- aff ect equilibrium unemployment. In addition, we show that as labor market frictions vanishes, firms do not hold liquid asset in equilibrium, suggesting a fundamental complementarity between labor market frictions and holding of liquid assets by firms. In this sense, the paper brings together the work on liquidity by Holmstrom anf Tirole (2011) with the traditional Mortensen Pissarides (2004) model of equilibrium unemployment. The model implies also that at times of adverse financial shocks, rms that are more leveraged are more likely to liquidate their assets and destroy jobs. Empirically, we test whether there is a causal link between firms leverage and job destruction at times of adverse financial shocks. We draw on rm-level data on employment adjustment matched with balance sheet records throughout the Great Recession and find that highly leveraged firms destroy more jobs during a nancial crisis.