UK Evidence on the Effects of Firm-Specific Characteristics on the Capital-Labour ratio under Capital Market Imperfections

Abstract

This paper contributes to the literature by introducing the nexus between financial constraints and the capital-labour uptake and by considering the capital-labour ratio to overcome the problems that have plagued investment literature -regarding the investment-cash flow sensitivity of constrained and unconstrained firms- that have focused only on investment ignoring employment decisions. The inclusion of the employment along with the capital can provide clear evidence about firms’ decisions on their allocation of funds between capital and labour. To detect any possible variation in our results across firms we use a sample of 17,350 quoted and unquoted UK firms over the period 1994-2004 and we estimate it applying panel data techniques. It is shown that balance sheet indicators such as leverage and cash flow result in lower K/L ratio, while the collateral ratio has a positive effect on the K/L ratio. In addition, when we differentiate the effects of the firm-specific characteristics across firms that are more or less financially constrained, we find that the former category exhibits a lower capital-labour ratio. Lastly, our results indicate that monetary policy shocks have an effect on the K/L ratio of more constrained firms.Financial constraints, Firm-specific characteristics, Capital-Labour ratio.