Financial Constraints and Employment Adjustment of Firms

The purpose of this study is to examine how the financial constraints that a firm faces affect the speed of its employment adjustment. The relationship between financial constraints and employment decisions can stem from the concept of labor hoarding. The concept suggests that costs associated with hiring, firing, and training employees lead employers who maximize profits to maintain a labor force larger than is technically necessary in response to short-term downturns in demand. However, financial constraints arising from a firm's restricted capacity to borrow are a limitation of labor hoarding. Finance is a key determinant of firm-level employment decisions because when financing is constrained, firms must adjust the capital and labor in relation to production. Labor hoarding and capital investment are similar in character. Firms that retain more workers than necessary must bear higher wage costs in the short term. The gains from labor hoarding emerge through lower recruitment and training costs when demand returns in the future. Thus, future gains from labor hoarding must be financed in the present day. When finances become constrained, firms cannot hoard as much labor as they desire and may be unable to stabilize employment. I will investigate the speeds of employment adjustment for a sample of Taiwanese manufacturing firms from 2008 to 2016. The 2008 financial crisis caused a downturn in worldwide economic activity. One real effect of the global financial crisis was the shortage of liquidity in the financial market. Firms in Taiwan were generally confronted with credit rations or credit granted with higher interest rates than before the crisis. The ability of firms to hoard labor and maintain employment stability was significantly influenced by the financial constraints they faced. Therefore, we expect that firms with more financial constraints will have higher employment adjustment speeds. This study will use a partial adjustment model for the adjustment of employment, and carry out the estimation by the generalized method of moments and multilevel mixed-effects. The research on labor and finance has been an emerging research topic in recent years. This study hopes to make contributions to this new research topic, and in practice, to provide advice to the firms intending to adjust their employment during the economic downturns.