Shielding Firm Value: Employment Protection and Process Innovation

Abstract

Following state-level legal changes that increase labor dismissal costs, firms increase their innovation in new processes that facilitate the adoption of cost-saving production methods, especially in industries with a large share of labor costs in total costs. Firms with high innovation ability exhibit larger increases in process innovation and capital intensity, and larger decreases in employment and employment growth. This allows them to increase labor productivity, operating performance, and to mitigate value losses. Our evidence highlights that, by facilitating the adjustment of the input mix when conditions in input markets change, innovation ability is a key driver of firm performance.

Keywords: Process innovation, Knowledge capital, Labor market frictions, Wrongful discharge laws

JEL Classification: D22, G30, J30, J63, O31, O32