Employment Protection, Investment, and Firm Growth

Abstract

We exploit the adoption of U.S. state-level labor protection laws to study the effect of employment protection on corporate investment and growth. We find that, following the adoption of these laws, capital expenditures decrease, resulting in firms growing sales at a slower rate. Our findings are consistent with theories predicting that greater employment protection discourages investment by making projects more irreversible. Supporting this theoretical channel, following negative cash flow shocks, firms are less likely to downsize operations in states that have adopted these laws but more likely to downsize operations in states that have not adopted these laws.

Keywords: Employment protection, Investment, Capital expenditures, Sales growth, Labor laws, Investment irreversibility

JEL Classification: G31, G33, J63, K31