Labor Duality and Leverage in Business Management

The leverage of companies is a concept that refers, in a strict sense to their level of indebtedness. A company with more financial leverage is one that has more debt in relation to its income, benefits or assets. However, the idea of ​​leverage can be understood, in a more general way, as applicable to any business commitment that has an intertemporal component. In particular, the concept of operating leverage extends the idea of ​​leverage to the existence of non-financial costs that the company has to cover in order to continue operating.

 

Leverage in Business

 

For example, we talk about a company having a high level of operating leverage, when its commercial margins are low and therefore requires high levels of purchases, production and inventories to obtain a unit of profit. The idea is that operating costs have an effect on the company similar to the payment of interest, and therefore, a good part of the known effects of debt on companies are also applicable to operating leverage. Following this idea, several works have recently emerged that analyze the company’s labor commitments as a component of operational leverage (for exampleSchmalz 2013, or Kuzmina 2013).

 

The article by Olga Kuzmina is of particular interest to the readers of Nada es Gratis, since it uses Spanish data. Why are Spanish data interesting to study the interactions between financial and operational leverage? The answer is that the exaggerated duality of the labor market in Spain facilitates finding changes in the operational leverage of companies.

 

While the article by Martin Schmalz that is based on data from EE. UU he is forced to look for small legal details between states, which generate slight differences in labor protection and look at their effects with a magnifying glass; Olga Kuzmina’s article can use variations in fixed and temporary workers and find economically more significant effects.

 

As can be seen, the duality of the Spanish labor market is very high, even when compared to other dual markets. First, because the differential in labor protection for permanent and temporary workers is large. Second, because the proportion of temporary workers is also very high.

 

How does this labor duality affect the financial leverage of companies? The question is interesting because it allows us to understand the interaction between operating leverage and financial leverage of companies. We hope that the relationship between both types of leverage will be substitution.

 

Leverage in Business

 

That is, when companies have more facility to adjust their work force (lower operating leverage), they also venture to borrow more (greater financial leverage), and vice versa. The following graphs show, at an aggregate level and by industry, the relationship between temporarily and leverage in Spain.

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