Human Capital and Investment Policy

The literature relates human capital costs to firm leverage (Berk, Stanton, and Zechner (2010) and Chemmanur, Cheng, and Zhang (2013)) and mergers and acquisitions (Lee, Mauer, and Xu (2017)). In this paper, we study the relation between a firm’s human capital costs and investment policy. We first present a simple theoretical setting to illustrate the positive effects of risky investment on average employee pay. We then empirically examine the relation between firms’ investment policies and human capital costs. Using two proxies for risky investment (cash flow volatility and unlevered stock return volatility), we find a significantly positive relation between risky investment and human capital cost (as measured by CEO compensation and average employee pay). The effect is stronger in low-pay firms than high-pay firms, and non-technology firms than technology firms. We further investigate four channels through which risky investment policy influences human capital costs: corporate diversification, R&D expenditures, advertising expenditures, and total value of acquisitions in a year. We find that while diversification negatively affects human capital cost, the rest of the three channels have positive effect on human capital costs. Our results are robust after accounting for the endogeneity of leverage, investment, and compensation of CEOs along with other robustness tests. Overall, our research contributes to the nascent but growing literature on the impact of human capital on firm investment and financing decisions. JEL classification: G31, G32, E24, J24