The elephant in the room: The impact of labor obligations on credit markets

Jack Favilukis, Xiaoji Lin, Xiaofei Zhao

Research output: Contribution to journalArticlepeer-review

30 Scopus citations


We show that labor market frictions are first-order for understanding credit markets. Wage growth and labor share forecast aggregate credit spreads and debt growth as well as or better than alternative predictors. They also predict credit risk and debt growth in a cross section of international firms. Finally, high labor share firms choose lower financial leverage. A model with labor market frictions and risky long-term debt can explain these findings, and produce large credit spreads despite realistically low default probabilities. This is because precommitted payments to labor make other committed payments (i.e., interest) riskier. (JEL D33, E23, E24, E25, E44, F23, G32)

Original languageEnglish (US)
Pages (from-to)1673-1712
Number of pages40
JournalAmerican Economic Review
Issue number6
StatePublished - Jun 2020

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