Labor Cost Stickiness and Managerial Decisions on Human Capital Adjustment

Abstract

On the basis of labor economics theories, we posit that adjustment in human capital accounts for a significant part of cost stickiness. Using the education level of employees as a measure of the quality of human capital, we find that labor cost changes driven by the adjustment of employee education level are sticky. This stickiness cannot be explained by the standard adjustment cost theory and is more salient during industry expansion. We further show that firms that actively adjust their employee quality during downturns experience improved future performance. Our findings are robust to alternative measures and specifications. Overall, this study extends the economic theory of sticky costs by showing that human capital adjustment drives cost stickiness. Moreover, such adjustments have long-term implications on the firm’s performance.