What Drives Firms' Hiring Decisions? An Asset Pricing Perspective

In a neoclassical dynamic model of the firm with labor market frictions, optimal hiring is a forward-looking decision that depends on both discount rates and expected cash flows. Empirically, we show that: a) the aggregate hiring rate of publicly traded firms in the U.S. economy negatively predicts stock market excess returns and long-term cash flows both in-sample and out-of-sample, and positively predicts short-term cash flows; and b) through a variance decomposition, the time series variation in the aggregate hiring rate is mainly driven by changes in discount rates and short-term expected cash flows, each contributing roughly to 50% of the variation, with no contribution from variation in long-term expected cash flows. Through a structural estimation of the model, we show that labor adjustment costs and, to a lesser extent, time-variation in the price of aggregate productivity risk, are essential for the model to replicate the empirical patterns.