Seeing the invisible: A test of rational expectations in the valuation of human capital.

Abstract

This paper investigates the relation in the U.K., U.S., Germany, and Japan between employee compensation and intangible firm value. Tests are conducted of the persistence of changes in wages relative to the average levels of persistence in changes in the other components of earnings, and the relation between changes in wages and value perceived by markets. Whether the persistence information in changes in wages is being used efficiently by markets is examined in tests of rational expectations.

The valuation tests indicate markets respond less to changes in wages in the U.K., U.S. and Japanese samples than to the average effect of the other components of income (significant incremental results were not found for the wage variable in Germany in either the market valuation or persistence tests). This suggests that wages and human capital are not "invisible" in the U.K., U.S. and Japan and provides support for the proposition that a portion of the wages expense is valued as an investment with future benefits. However, changes in wages are found to have greater persistence than the average levels of persistence in the changes in other components of earnings in the U.K., U.S. and Japan, a result seemingly inconsistent with wages having greater future valuation benefits than other components of earnings. Rational expectations tests indicate that this inconsistency is not explained by market inefficiency.