Wage Differentials, Firm Investment, and Stock Returns

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.