Cash Flow Constraints on Labor and Debt Co ntracts joint with Garth Baughma and Marco Brianti
Abstract:
In an eff
ort to understand the interactions between labor and capital, this paper co
mbines a standard model of labor markets, the competitive search framework,
with two standard financial frictions, costly state verification and cash
flow constraints. Qualitatively, the model provides a novel explanation for
the priority of unpaid wages in US bankruptcy, and suggests that some esti
mates of the indirect costs of bankruptcy are misspecified if they ignore w
ages. Quantitatively, the model reasonably matches a number of moments, and
provides rich predictions about the relationships between a number of vari
ables. We conclude that the interaction between these frictions should be t
aken seriously and point out potential implications for studies of business
cycles, fiscal analysis, labor economics, bankruptcy policy, and optimal c
apital structure.