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 labor ratios—an effect driven by both increases in capital investment and decreases in employment. By facilitating the adjustment of the input mix when conditions in input markets change, innovation ability allows firms to mitigate value losses and is a key driver of their performance.

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

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