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CEP discussion paper
Labor and the Market Value of the Firm
Monika Merz and Eran Yashiv
May 2005
Paper No' CEPDP0690:
Full Paper (pdf)

JEL Classification: E22; E23; E24;G12

Tags: production-based asset pricing; labor market frictions; gross flows; q-model; gmm

What role does labor play in a firm’s market value? We explore this question using a production-based asset pricing model with frictions in the adjustment of both capital and labor. We posit that hiring of labor is akin to investment in capital and that the two interact, with the interaction being a crucial determinant of the time series behavior of market value. We use aggregate U.S. corporate sector data to estimate firms' optimal hiring and investment decisions and the consequences for firms' value. The model generates a good fit of the data. We decompose the estimated market value, thereby quantifying the link between firms' value and gross hiring flows, employment, gross investment flows, and physical capital. We find that a conventional specification -- quadratic adjustment costs for capital and no hiring costs -- performs poorly. Hiring and investment flows, unlike employment and capital stocks, are volatile and both are essential to account for market value volatility. A key result is that firms' value embodies the value of hiring and investment over and above the capital stock.

American Economic Review, 2007, Volume 97, Issue 4,1419-1431