Two Essays on Labor Heterogeneity

Labor heterogeneity limits firm flexibility, subsequently affecting a firm's capacity to adapt and grow within a dynamic economic landscape and to formulate effective financial strategies. Firms with high labor heterogeneity tend to incur significant labor adjustment costs, making it costly and challenging to adjust their workforce in response to economic changes. While retaining skilled labor can be advantageous in preserving valuable human capital, it also incurs considerable economic costs that significantly influence firms' financial strategy and decision-making processes. This dissertation comprises two essays that explore the implications of firms' dependence on skilled labor. The first essay empirically investigates how labor adjustment costs affect capital allocation efficiency. Using data from US-listed firms between 1999 and 2021, the findings reveal a negative relationship, indicating that retaining skilled labor reduces the responsiveness of investment to value-added growth. This effect is attributed to ineffective monitoring, as labor adjustment costs increase agency costs. Notably, this negative relationship became insignificant during the 2001- 2003 period, following the dotcom crisis, when there were widespread layoffs of skilled workers. The second essay investigates how labor adjustment costs affect a firm’s externally financed growth. Using a sample of US firms between 1999 and 2022, we find a positive relationship between labor adjustment costs and externally financed firm growth. For firms with high labor adjustment costs, external financing becomes important for growth because firms hoard precautionary cash in the face of higher firm risks. Further analysis shows that equity is the more important source of external funds for firms with high labor adjustment costs. The retention of skilled workers elevates conflicts between financial and non-financial stakeholders of the firm. Ineffective monitoring is the channel connecting labor adjustment costs and externally financed growth. The results remain unchanged after a battery of robustness checks.