Declining Labor Share and Corporate Finance

Although fluctuations in the labor share of income over the business cycle are a natural feature of the economy, a long-run decline requires a deeper explanation. Mirroring a long-term trend observed across the world, the labor share of income in Japan has been declining since the early 2000s. Sluggish wage growth and an increase in dividends and retained earnings suggest that this decline reflects a change in the distribution of firms’ value added. In this paper we examine whether a declining labor share has been accompanied by increased retained earnings. In particular, we analyze the relationship between firms’ employment levels and per capita labor costs on the one hand and their financing behavior on the other. Our results show that firms with a main bank relationship have been increasing precautionary savings at the same time as they have increased employment. On the other hand, firms without a main bank have been accumulating excess cash on their balance sheets regardless of whether they have been increasing or decreasing their employment levels. These observations have been contributing to a decline in the labor share of income. JEL Classification Codes:G3, J4