Inside debt, labor investment and cost stickiness

Abstract

This thesis comprises two essays examining the relationships among CEO inside debt, labor investment and cost stickiness. First essay documents how inside debt affects corporation’s labor investment behavior using U.S. sample. Manager’s inside debt holdings have been shown to lead the manager to seek more conservative policies and place more attention to firm’s long-term survival due to deferred payments. As labor investment has been recognized as an integral factor for firm’s long-term survival and growth, the inside debt is expected to lead the manager to approach optimal labor investment level as the manager with more inside debt holdings are more interested in firm’s long-term survival. On the other hand, increased conservatism due to higher inside debt holdings would induce the manager to decrease labor investment. Under labor overinvestment circumstance, the impact of increased long-term horizon coincides with that of increased conservatism, but under labor underinvestment situation, these two impacts contradict each other. This prediction is empirically supported by positive association between manager’s inside debt holdings and optimal labor investment for labor overinvestment subsample and insignificant relationship for labor underinvestment subsample. More robust two-stage regression and propensity score matching analyses to address endogeneity concerns also confirm the results. Overall, the results consistently imply that the inside debt mitigates the agency problem between equity holders and debtholders. Second essay shows how the inside debt affects cost stickiness. Main factors of cost stickiness include economic and agency factors

i.e. the manager increases cost stickiness not only to the degree economically optimal to the firm, but also to the degree exceeding that level for the manager’s benefit. As the inside debt strengthens the manager’s conservatism and long-term risk averseness, it is expected that the managers with more inside debt holdings would decrease the cost stickiness in excess of the optimal level, to approach the optimal cost stickiness level. This prediction is empirically supported by negative relationship between inside debt and cost stickiness. These results imply that inside debt can mitigate the agency problem in cost stickiness.