Employment Protection Laws and Corporate Cash Holdings

56 Pages Posted: 1 May 2016 Last revised: 22 Nov 2019

See all articles by Ahmet Karpuz

Ahmet Karpuz

Loughborough University - School of Business and Economics

Kirak Kim

University of Bristol - School of Economics Finance and Management

Neslihan Ozkan

University of Bristol - School of Economics, Finance and Management, UK

Date Written: November 1, 2019

Abstract

We study how employment protection laws (EPLs) affect corporate cash-holding decision. By exploiting within-country changes in EPLs across 20 OECD countries as a source of variation in labor adjustment costs, we show that following an increase in the stringency of EPLs, firms’ cash holdings increase significantly. This relationship is stronger for firms with high labor turnover, no multinational presence, or financial constraints, indicating that labor adjustment cost raising distress risk is the mechanism in play. Cash buffers created by firms faced with stricter EPLs help them mitigate the underinvestment problem in subsequent episodes of industry-wide distress. Consistent with this precautionary motive, the market’s valuation of excess cash is positively associated with the EPL strictness. We further demonstrate that the response of cash policy to changes in EPLs is distinct from that of debt policy or investment policy. Our evidence highlights the role of interaction between labor-market and financial frictions in determining the level and the value of corporate cash.

Keywords: employment protection, labor adjustment cost, cash holdings, value of cash

JEL Classification: G31, G32, G38, K31

Suggested Citation

Karpuz, Ahmet and Kim, Kirak and Ozkan, Neslihan, Employment Protection Laws and Corporate Cash Holdings (November 1, 2019). 30th Australasian Finance and Banking Conference 2017; Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2773072 or http://dx.doi.org/10.2139/ssrn.2773072

Ahmet Karpuz

Loughborough University - School of Business and Economics ( email )

Epinal Way
Leics LE11 3TU
Leicestershire
United Kingdom

Kirak Kim (Contact Author)

University of Bristol - School of Economics Finance and Management ( email )

12 Priory Road
Bristol, BS8 1TU
United Kingdom

Neslihan Ozkan

University of Bristol - School of Economics, Finance and Management, UK ( email )

United States

HOME PAGE: http://www.bristol.ac.uk/accounting/staff/ozkan.html

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