Capitalized Labor Contracts

Abstract

This paper investigates the effects of capitalizing expected compensation costs associated with labor union contracts. The approach treats employment similarly to capitalized leases. The value of capitalized compensation is comparable in magnitude to the value of all currently recognized assets, indicating a potentially important role for compensation. The paper demonstrates that the increase in financial leverage due to capitalizing compensation costs is positively correlated with market model beta . This effect is seen both in simple correlations and in regressions controlling for (conventional) financial leverage, operating leverage, and other factors. In addition, adding capitalized compensation to a regression of market value of equity on book value of equity produces a positive regression coefficient on the compensation variable. This indicates that equity markets price employment as though it produces value in excess of its cost.

JEL Classification: D24, G32, J30, M41