Do talents affect financial decisions?

Rui Silva, Professor of Finance at London Business School (LBS) - June 1st, 2017
Do talents affect financial decisions? ©AdobeStock_Kentoh

Talented workers are the first to leave a firm in financial distress. Simultaneously, this makes  recruiting new skilled workers much more difficult. Labor fragility is therefore a key determinant of a firm capital structure: CFOs assess the workforce risk associated with high leverage when deciding to issue debt or equity. This is especially true for companies relying on skilled labor. 

Rui Silva

Rui Silva is an Assistant Professor at the London Business School. He holds an MA and a PhD in Economics from The University of Chicago. His main research focus on corporate (...)

How can financing decisions affect the allocation of talent? This is the question Professors Baghai, Silva, Thell and Vig explore in the paper "Talent in Distressed Firms: Investigating the Labor Costs of Financial Distress". Their research shows that among the risks associated with a high level of debt, losing skilled workers is a prominent one. 

Such talents being central to the running and development of a firm, can cause their departure to endanger the future of the company. CFOs therefore take this risk into account when making key financial decisions, a result that helps us to understand the determinants of firms’ capital structure better. 

Who are the first to leave the ship?

To study the link between labor fragility and leverage, the researchers look at very detailed data on Swedish firms and their employees. Their dataset contains the history of employment for all Swedish individuals between 1990 and 2011, as well as the information on wages and socio-economic characteristics. They also collect the results of military enlistment tests, similar to IQ tests, available for Swedish males which give them a proxy for individuals’ cognitive ability. Talented workers are defined as Swedish males having scored in the top 5 percent at this test. On the firms’ side, they had access to firm-level financial statement and detailed information on bankruptcy filings.

Armed with this comprehensive dataset, they focus on the evolution of Swedish firms’ workforce around bankruptcy. The authors find that the most talented workers are 30% more likely to leave compared to the average worker. Meanwhile, the recruitment of talent does not catch up, implying an overall drop in the quality of workers within the firm. They finally confirm all their results using advanced econometric methods as well as specificities of Swedish labor laws.

Despite being intuitive, this result is not at all obvious from a theoretical point of view. On one side, a skilled worker may choose to exit given that it will be easy for them to get a new job. On the other side, a skilled worker may be more patient as they won’t have to accept a lower wage from another firm in case of liquidation. Additionally, they could possibly have the access to information that may help them to distinguish between economic and financial distress . This finding thus constitutes a major step towards a better understanding of the dynamics of the labor market.


Firms whose employees are especially skilled are more reluctant to use debt rather than equity financing.

What consequences for firms’ financing decisions?

After having established the propensity for skilled workers to leave firms in financial distress, the researchers then ask how such a risk affects firms’ financing decisions. Indeed, one of the leading theory of firms’ capital structure decision, namely the trade-off theory , is that managers weight the advantages of debt, such as the interest tax shield, with its disadvantage, e.g. bankruptcy costs (legal costs or loss of reputation). In a nutshell, the tradeoff theory argues that CFOs do a risk/benefit analysis when deciding their level of leverage. According to the above presented findings, a high level of leverage also has a cost if it leads to the loss of talents. Thus, this theory predicts that firms that mostly rely on skilled labor (firms in R&D, IT, finance…) should have a lower leverage compared to companies with a less talented workforce.

They have tested this hypothesis both for Swedish and US firms and indeed have found that this is the case. All else being equal, firms whose employees are especially skilled are more reluctant to use debt rather than equity financing. This confirms the predictions of the trade-off theory and deepens our understanding of the determinants of firms’ capital structure, one of the most hotly debated subjects in corporate finance.

The authors also look at the interaction between labor fragility, firms’ governance and firms’ value. They note that labor fragility may have a bright side as it can act as a disciplining device for firms with weak governance mechanism: talent fragility disciplines managers. Looking at a firm’s value, they find that the value of firms with poor governance is higher when the mobility of talents is higher, a clear sign that markets understand the governance benefits associated with the threat of losing key employees.

The new economy and human capital

Those findings are especially interesting in light of the development of the “new economy”. For high-tech firms relying heavily on R&D, human capital is more important than physical capital. With their value being based on their capacity to innovate constantly, they are highly exposed to the risk of losing talents. Understanding the specificities of the challenges faced by those firms, and their implications for their financial decisions is thus a question of first importance that the authors help to better assess.

This text was written by Charles Boissel, HEC Paris PhD, based on the working paper "Talent in Distressed Firms: Investigating the Labor Costs of Financial Distress" co-authored by Ramin Baghai (Stockholm School of Economics), Rui Silva (London Business School - Department of Finance), Viktor Thell (Stockholm School of Economics), Vikrant Vig (London Business School). This study was presented by Rui Silva during the Adam Smith Conference at HEC Paris on March, 2017.