External Finance, Leverage and Human Capital Asset Liquidation. Evidence from Eastern and Central European Firms.

A number of empirical studies have identified channels through which banking and financial crises transmit to the real economy. In particular, the financial accelerator model requires firms' financial condition to impact labour. This paper contributes to investigating this link by focusing on a set of countries that underwent dramatic changes in the few decades prior to the Global Financial Crisis, namely Central and Eastern European countries. The deregulation of labour markets that accompanied the transition of former socialist economies has meant the rapid spread of flexible forms of employment (particularly temporary employment), where forms of employment protection are sizably reduced. This paper investigates the response of different forms of employment to firms' debt during the years preceding and following the onset of the GFC. Unlike other studies that have investigated the impact of firms' financial constraints and leverage on employment, this study finds that the transmission to the labour markets originated from previous investments in fixed assets that were only partially covered by internal finances. Firms' debt impacted more on the permanent workforce than on the temporary one, a result that questions the generality of the empirical evidence previously reported on this issue. Finally, firms experiencing sharp changes in their ability to meet fixed assets investments with their internal funds laid off high human capital employees more than unskilled segments of their workforce. This result confirms the one that Milanez (2012) recently found in a sample of Californian firms during the GFC. Both these studies, although different in the way they measure workers' skill, contradict theoretical labor economics predictions that firms lay off workers in inverse order of the degree of human capital.