Corporate financial leverage in Canadian
manufacturing: Consequences for employment and inventories
by Andrew Heisz
and Sébastien LaRochelle-Côté
Business and Labour Market
Analysis Division
Analytical Studies Branch research paper series, No. 217
Context
Firms
typically prefer to maintain their workforces when sales drop because of the costs
associated with hiring and severance of employees. A firm with higher debt levels
will have a harder time maintaining their workforces because they have more cash
flow dedicated to interest payments and may find it more difficult to borrow additional
capital (i.e. they face credit constraints). The proportion of debt in Canadian
firms increased substantially during the last four decades and this study suggests
that less employment stability is a possible consequence of higher leverage at
the firm.
Objectives
The paper investigates first, the link between
financial structure and employment growth and second, the link between financial
structure and inventory growth among incorporated Canadian manufactures from 1988
to 1997.
Findings
Firms with higher leverage shed nearly 10% more
labour than finically healthier firms for a given drop in product demand, suggesting
that credit constraints may be an important factor in amplifying a firm's response
to a decrease in sales.
The influence was larger during the recession of
1990 to 1992 and was also greater in sectors that experienced larger cyclical
fluctuations. These stylized facts are consistent with the idea of a "flight to
quality" in credit markets, and that credit constraints amplify a firm's response
to a decrease in sales.
Data source: T2 corporate tax
records linked to Longitudinal Employment Analysis Program 1988-1997.
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