Labor Leverage, Firms Heterogeneous Sensitivities to the Business Cycle, and the Cross-Section of Returns

Abstract

Corporate profits are volatile and highly procyclical in the aggregate, but there is substantial heterogeneity across firms in the extent of this procyclicality: I document that firms with lower productivity or higher book-to-market have more procyclical profits. A simple static profit maximization problem can rationalize this. Firms which have more procyclical profits should also have higher betas and expected returns. Estimating an asset pricing model with aggregate productivity and aggregate real wage as factors validates this prediction. This economic story helps account for the size and value premia, and yields rich empirical implications by linking firms' real and financial characteristics.

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