Labor input is an important factor in a firm’s production and affects stock return. We use an optimization model to explore the stock return-labor hiring relation with the effects of employment frictions and labor supply. Our model illustrates that labor hiring is negatively related to the expected stock return from the discount rate channel; the negative return-hiring relation becomes steeper when the firm’s employment frictions are higher; positive labor supply shock leads to a flatter return-hiring relation. Using Chinese-listed firm data, we provide evidence for the existence of the return-hiring relation and the impact of employment frictions and labor supply confirming the theoretical predictions.

Introduction

Traditional studies of stock returns mainly focus on the effects of a firm’s financial variables and relevant systematic risks. These studies usually leave no role for the labor input by assuming that labor can be adjusted without costs. However, the labor market does experience frictions. For example, the labor adjustment costs paid by a firm when adjusting the labor force size reduce the income attributable to investors and thus should be reflected in its asset prices. Danthine and Donaldson (2002) suggest the impact of operating leverage on stock returns due to labor contracts. More recent studies have already looked into the effect of the labor force on financial markets and find some crucial labor features significantly affect asset prices. Donangelo (2014) suggests that labor mobility has a positive effect on a firm’s stock returns since it increases the firm’s operating leverage. Favilukis and Lin (2016a,b) report that stock returns increase with wage rigidity because smoother wages make dividends riskier. Donangelo et al. (2019) find the relative size and inflexibility of labor costs result in labor leverage for a firm, and higher labor share increases the risk and equity premium. Labor hiring, as an important labor market characteristic, is closely related to the development of a firm needing competent employees. Thus, some studies investigate the impact of labor hiring.