The effects of labor leverage and labor flexibility on equity risk and cost of capital

As a key production factor, labor affects a firm's operating characteristics, overall performance, and management decisions. Specifically, this research investigates the differential impact of labor leverage (fixed labor costs) and labor flexibility (variable labor costs) on income volatility, equity risk and cost of capital.; Three studies are presented that examine the impact of labor leverage and labor flexibility on firm performance. The first study analytically demonstrates that labor flexibility reduces income volatility, equity risk, and the cost of capital, while labor leverage increases equity risk and the cost of capital. In the second study, based on a large sample of traded firms over the period 1960--2002, empirical results indicate that labor leverage is positively associated with equity risk and cost of capital, while labor flexibility is negatively associated with these same risk constructs. In a contextual setting, the third study investigates the effects of demand uncertainty and labor flexibility on income volatility in the labor-intensive health care industry (Freeland et al. 1979). This third dissertation study finds that demand uncertainty is directly associated with the use of certain forms of flexible labor (overtime and temporary labor) and that these flexible forms of labor are inversely associated with income volatility. Collectively, these three papers illustrate how managers use labor flexibility to reduce risk and demonstrate how managers operationalize labor flexibility in day-to-day decision making.; Overall, the dissertation research results imply that managers can use a firm's compensation policy not only to increase productivity (Banker et al. 2000; Nayar and Willinger 2001) but also to reduce the firm's income volatility, equity risk and the cost of capital.