Labor leverage and firm risk: Evidence from Korea

Labor expenditure can induce a form of operating leverage at the firm level due to the relative smoothness of wages compared to output. This study investigates the effect of labor-induced operating leverage (i.e., labor leverage) measured by labor share on a firm's risk dimensions in the Korean stock market. We find that labor share increases both equity returns and the default probability at the firm level. Moreover, the amplification of liability risk translates into the riskiness of a firm's assets proxied by asset volatility. Finally, we show that the value premium is stronger for high labor share firms, suggesting a new channel of the book-to-market effect in the cross-section of returns.