Outside Employment Opportunities, Employee Productivity, and Debt Discipline

We analyze how changes in labor market conditions influence the relation between a firm’s debt level and employee productivity. We document that better (worse) outside employment opportunities create a more negative (positive) relation between employee productivity and debt at both the firm and industry levels. Moreover, NAFTA, a quasi-natural experiment that affected employment opportunities in certain industries, resulted in a more positive productivity-leverage relation for firms in these industries. Our findings suggesting that outside employment opportunities affect the disciplining role of debt illustrate how labor market conditions impact the efficacy of corporate financial policies.