Findings and Discussion

Labor-shortage exposure contains information about firm value. Firms with greater exposure experience lower cumulative abnormal returns around earnings calls, indicating investors view labor-shortage discussions as unfavorable news. The effect also extends beyond the announcement window. An interquartile increase in exposure predicts a 0.552-percentage-point decline in stock returns over the following year and a 0.104-percentage-point decline in one-year-ahead industry-adjusted ROA.

These performance effects are consistent with the economics of labor scarcity in imperfectly competitive labor markets. Firms may be able to hire more workers by raising pay, but wage adjustments can increase compensation costs for both new and incumbent employees. Labor-shortage exposure also predicts higher future growth in per-employee staff expenses, suggesting managers’ discussions capture real hiring frictions and wage pressure rather than general negative sentiment.

The corporate response appears in the firm’s input mix. Labor-shortage exposure predicts higher capital expenditures and R&D in the following year, along with fewer employees per million dollars of assets. This pattern indicates firms facing scarce or more costly labor shift resources toward nonlabor inputs. The adjustment is not large enough to erase the performance costs immediately, but it indicates labor shortages affect capital allocation rather than only current wage bills.

The innovation evidence shows where this adjustment is concentrated. Exposed firms produce more production-process patents over the next three years, while the relation with nonprocess patents is statistically weak. Process patents are tied to how firms produce goods and services. They are more closely connected to efficiency, automation, and workflow redesign than to new products for sale. Labor scarcity therefore appears to redirect innovation toward production methods that can economize on human labor.

The AI results point in the same direction. Firms exposed to labor shortages increase investment in AI-related personnel and produce more AI-related patents. These findings add an important channel to the discussion of automation. Firms adopt AI not only because the technology frontier advances, but also because they have stronger incentives to adopt labor-saving technologies when hiring constraints raise the cost of relying on workers.

The response differs across firms. Companies with greater wage-setting power show weaker wage responses and stronger reliance on process innovation. Firms with repeated exposure to labor shortages increase R&D and process innovation more strongly, consistent with the idea that persistent constraints justify more durable production changes. Financially constrained firms respond differently: they raise wages more and invest less in labor-saving technologies. Access to finance therefore shapes whether firms can respond to labor scarcity through structural adjustment or remain exposed to rising labor costs.

The pandemic period provides a stress test for the measure. Firms that had already discussed labor shortages in 2018 and 2019 performed worse during 2020 and 2021 than firms with no prior exposure. Their stock returns and ROA were 8.7 and 3.8 percentage points lower per year, respectively, relative to nonexposed firms. Preexisting labor-shortage exposure therefore identifies firms that are especially vulnerable when labor markets tighten sharply.

The results remain robust when the authors use alternative constructions of the exposure measure, separate management presentations from Q&A sections, control for time-invariant CEO characteristics, use industry-level exposure, and apply a Bartik-style instrumental variable approach. Additional tests show capital expenditures and process innovation help reduce subsequent exposure and mitigate future performance losses.