This paper argues that expectations are an important element that need to be included into the analysis of the effects of the minimum wage on employment. We show in a standard matching model that the observed employment effect is higher the lower is the likelihood associated to the minimum wage variation. On the other side, there is a significant anticipation effect, ignored in the literature. This property is able to explain the controversial results found in the empirical studies. When the policy is anticipated, the effect at the time of the actual variation is small and hard to identify. The model is tested on Spanish data, taking advantage of the unexpected change in the minimum wage following the election of Zapatero in 2004.

Minimum wages were first introduced in Australia and New Zealand in the late 19th century and are now in force in more than 90% of all countries.1 Despite its widespread use, the minimum wage is a debated issue. Its supporters assert that it helps prevent the excess of exploitation in the labor market and increases the living standards of the lowest paid up to some minimum acceptable standards. Detractors claim that the minimum wage may price low'skill workers out of market, harming rather than helping the poorest workers.

The aggregate stock market index and the exchange rate are known to have a very low correlation with any other measurable macroeconomic variable (Frankel and Rose (1995), Rogoff (2001)). This motivates us to examine a new financial market variable called order flow in its relationship to stock and exchange rate returns. Order flow is the net of buy minus sell initiated orders. In the forex market, daily exchange rate returns and daily forex order flow show a remarkably high correlation (Evans and Lyons (2002a, 2002b, 2002c)) and even permanent changes in the exchange rate appear to be explained by order flow. Unfortunately, most of the microstructure literature features order flow as an exogenous variable. Its very origin remains unexplained and open to different interpretations.

This paper advances the existing literature in two directions. First, we add micro foundations to the existing literature on order flow. We link the order flow concept to heterogenous belief changes of investors and therefore allow for a coherent interpretation. It is argued that the portfolio reallocations resulting from belief changes are predominantly pursued through trade initiation. Recent evidence from the microstructure literature (Hollifield et al. (2004)) confirms that the likelihood of trade initiation increases with the magnitude of the deviation between agents’ valuations and the current mid price of a stock. Since order flow represents a summary statistic on the direction of trade initiation, it directly identifies aggregate belief changes. Second, we propose a two country model in which two equity markets and the exchange rate market can be analyzed jointly. The multi market setting imposes testable restrictions on international market interdependence.

Wage differentials across observationally equivalent workers are both sizable and persistent in reality, and empirical work has given stylized fact status to several relationships between worker wages and employer characteristics. The employer size5wage effect is perhaps the strongest such stylized fact: everything else equal, larger firms or plants pay higher wages, as noted by Krueger and Summers (1988) and exhaustively documented by Brown and Medoff (1989) and Oi (1999), who argues that the relationship between wage and employer size was already observed some hundred years ago. An apparent relationship between wages and employer size might be spurious in raw data, reflecting for example the fact that larger employers hire higher quality workers, or pay higher wages to compensate for inferior working conditions (Masters, 1969), or face higher risk of unionization (Podgursky, 1986), share with workers their above normal profits (Weiss, 1966; Mellow, 1982), or need to offset a lower applicant to job vacancy ratio (Weiss and Landau, 1984) or reduce costly monitoring (Oi, 1983). The employers size, however, remains significant in fixed effect wage equations even when they include all variables relevant to such alternative explanations.

Empirical evidence also indicates that wage dispersion across production units is also related to employment levels. Davis and Halti sector wage dispersion falls sharply with establishment size for nonproduction workers, and mildly for production workers. Like the mean effects, this second moment wage5size effect is robust to the inclusion of control variables such as establishment level union density and indicators of worker quality.

Since the seminal Modigliani and Miller (1958) irrelevance propositions, financial economists have developed a number of theories in which the capital structure choice becomes relevant. The two most important and dominant theories of capital structure include the trade-off and pecking order theories (see Harris and Raviv, 1991 for a review). The trade-off theory, based on research on taxes (Modigliani and Miller, 1963) and bankruptcy and financial distress costs (Warner, 1977) and the insights from the agency literature (Jensen and Meckling, 1976), suggests that firms have a unique optimal capital structure that balances between the tax advantage of debt financing (i.e. debt tax shields), the costs of financial distress and the agency benefits and costs of debt (see Bradley et al., 1984; Leary and Roberts, 2005; Strebulaev, 2007).

The pecking order theory developed by Myers and Majluf (1984) and Myers (1984) does not predict an optimal capital structure. Under the assumption of asymmetric information whereby outsider investors know less about the value of the firm and the new investment opportunities than inside managers, firms avoid issuing equity and risky securities that are sensitive to mis-pricing and adverse selection. The pecking order theory predicts a strict preference of corporate financing, in which new investments are financed by internal funds first, then by low-risk debt and hybrid securities such as convertibles, and equities as the last resort. There is no optimal capital structure and the observed debt level is the cumulative result of the ‘pecking order’ financing behaviour over time.