Firing Costs and Capital Structure Decisions
67 Pages Posted: 16 Feb 2014 Last revised: 5 Mar 2016
Date Written: February 10, 2016
I exploit the adoption of state-level labor protection laws as an exogenous increase in employee firing costs to examine how the costs associated with discharging workers affect capital structure decisions. I find that firms reduce debt ratios following the adoption of these laws, with this result stronger for firms that experience larger increases in firing costs. I also document that, following the adoption of these laws, a firm’s degree of operating leverage rises, earnings variability increases, and employment becomes more rigid. Overall, these results are consistent with higher firing costs crowding out financial leverage via increasing financial distress costs.
Keywords: Capital structure, Firing costs, Employment protection, Financial distress costs
JEL Classification: G32, G33, J63, K31
Suggested Citation: Suggested Citation