Wage Contracts and Financial Frictions

Résumé

Financial crises often lead to drastic reductions in firms’ access to credit, impacting significantly their ability to finance their operations. This paper shows that firms can partly offset the effects of these shocks by optimally adjusting their wage bills. We augment a baseline financial frictions model to account for two well documented features of the labor market: wages are set at the firm level and within long-term employment relationships. Because of these features, wage dynamics de pend on the financial conditions of firms, reflecting a trade-off between smoothing wages of risk-averse workers and investing in capital. We validate the model predictions on wage dynamics using matched employer-employee data from Italy. We find that more constrained firms adjust wages more in response to idiosyncratic shocks. In addition, firms that suffer the most during recessions backload wages by paying workers relatively more in the future than today. When matching these statistics with our general equilibrium model, we find that these wage adjustments reduce the sensitivity of output to financial shocks by 20%: wage backloading enhances investment and job creation while improving allocative efficiency. We conclude by studying policies aimed at reducing inputs cost during recessions. Our findings show that these wage adjustments diminish the effectiveness of temporary payroll subsidies while enhancing the effectiveness of temporary investment subsidies in stimulating output.