Financial Reporting Quality and Employment: The Case of Refinancing Risk

Abstract

We examine the role of financial reporting quality in facilitating corporate employment. Labor creates operating leverage due to wage rigidity and lacks collateral value, both of which increase credit risk and the importance of information in debt markets. We use firms’ predetermined debt maturity schedules to identify when firms face credit constraints stemming from refinancing risk. We find that while refinancing risk is associated with reductions in net hiring, this effect is mitigated by higher quality financial reporting. This result is stronger when the informational sensitivity of debt is expected to be higher, including when labor-induced operating leverage is more significant (labor intensive or unionized firms) and when conflicts of interest among capital providers are more severe (firms with higher likelihoods of default or more heterogeneous debt structures). We further find that high quality financial reporting also mitigates the adverse effect of refinancing risk on employee turnover rates. Overall, our results highlight the importance of financial reporting quality in facilitating firm-level employment by mitigating frictions in both credit and labor markets.