This paper examines the effect of corporate misconduct on labor leverage, i.e., the
proportion of labor costs to firm-level output. We find a positive relationship between
corporate misconduct penalties and labor leverage, highlighting the role of
labor leverage-induced increased earnings sensitivity to demand shocks and downside
risks. Lower firm-level output and corporate penalties are associated with
higher labor leverage. Employee workplace safety-related violations primarily influence
the labor leverage dynamics. Further, these increasing labor leverage effects
of corporate misconduct are pronounced mainly for informationally opaque firms
and firms subject to weaker governance effects and higher product market competition.
Overall, our study offers critical implications for policymakers and regulators,
emphasizing the labor share consequences of corporate misconduct by spotlighting
the economic mechanism through which corporate penalties could affect the cost
and output functions of penalized firms.