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Open Access Publications from the University of California

Human Capital Investment, Cash Flow Risk and Capital Structure Dynamics

  • Author(s): Zhang, Xiaolan
  • Advisor(s): Lustig, Hanno
  • et al.

My dissertation explores the financial effects of firms' growing reliance on intangible capital in their production technology. I examine the fundamental link between the cash flow risk, financial decision-making and the accumulation of firm-level intangible capital both in theory and in empirics.

In Chapter one, I document that public firms in the United States that provide better insurance against productivity shocks to their workers experience higher cash flow volatility. Difference in intra-firm risk sharing between workers and capital owners accounts for more than 50\% of the variation in firm-level cash flow volatility. I develop a theory in which wages can act either as a hedge or as leverage, depending on the history of the productivity shocks the firm has faced. Heterogeneous roles of workers in the firm are derived by analyzing the dynamic equilibrium wage contracts between risk-neutral owners and risk-averse workers who can leave with a fraction of the accumulated human capital. Owners of the firm will optimally bear more risk when the current value of the firm's human capital is lower than the peak value it has reached. The model successfully explains the joint distribution of cash flow volatility and the wage-output sensitivity. Also, the model produces predictions for the dynamics of cash flow volatility that are consistent with the time series properties of the firm-level data.

In Chapter two, we provide the theoretical and empirical analysis on firms' dynamic capital structure decision with the presence of intangible capital accumulation. In the US publicly traded firm sample, the intangible capital investment is financed mainly through employee-initiated equity issuance. We propose a theory in which firms issue self-enforcing debt contracts to external investors and also offer long-term wage contracts to the employees with limited commitment. We show that the long-term wage contract optimally serves as financing instrument for the shareholders. Firms dynamically trade off between financial debt and employee financing until their intertemporal marginal rates of substitution are equal. The accumulation of intangible capital in the production imposes two effects on the financial structure: precautionary effect and intangible capital overhang effect. The structural estimation indicates the dominating effect of intangible capital overhang. Identifying the different financing channel provides a new solution to the contrasting secular trend in corporate net debt ratio and the firms' increasing importance on intangible capital in the production.

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