Employment adjustment and financial tightness – Evidence from firm-level data

Abstract

Firms tend to only partially adjust their workforce to changes in output. Typically, labour is hoarded in downturns; subsequently, firms have to hire less workers in upturns, but they can do so only if they can bear the current costs of keeping superfluous workers so that the firms can save rehiring costs in the future. Therefore, labour hoarding can be seen as an investment and may be influenced by factors, such as the firms’ financial shortages, that tend to impede investments. Using Swiss firm-level data, we show that for firms in financially strained situations, the sensitivity of employment to fluctuations in output increases considerably. When output changes, financially tighter firms resize their labour force more than firms that have abundant funding. Both limited internal funding opportunities as well as the reduced access to external finance are important. The strongest impact, however, is observed when internal and external financial tightness occur jointly. In that case, compared to firms that are not in a financially strained situation, firms in a financially strained situation lay off twice as many employees. The amplifying effect of financial tightness is similar in upturns and downturns, implying that financially tight firms not only reduce their workforce more when demand decreases but also hire more labour when demand increases.