Fair wages, labor relations and asset returns

The paper investigates the nexus between labor and financial markets, focusing on how labor union’s attitude in the wage-setting process and the firm’s investment strategy affect asset returns. We assume that the labor union’s relative preferences between wage and employment depend on selected measures of firm’s financial performance. The paper shows that if the labor union ties its preference for wage to the firm’s dividends (or to any other quantity measuring available liquidity), then the volatility of the firm’s returns increases. Consequently, equities have to grant high expected returns in order to remunerate the increased volatility. This mechanism offers an explanation for the “equity premium” (that is the difference between the equity return rate and the risk free rate). It is a welcome result that the simulated excess return is about the empirical estimate and that it is obtained with a plausibly low parameterization of the shareholders’ risk aversion.