Firing Costs and the Stock Market

Abstract

We study the effects of firms' firing costs on stock market measures of risk and return by exploiting variation in wrongful-discharge laws (WDLs) adopted by U.S. states. We find disparate effects depending on the type of WDL that mirror how intra-firm risk sharing between labor and capital differs in states that adopted the respective laws. WDLs that increase mean returns, return volatility, Sharpe ratios, and factor betas are associated with more sticky employment and hence more risk-bearing by capital markets. Conversely, equity risk measures are lower in states where WDLs address agency frictions such that workers bear more risk via flexible wages.

Keywords: Expected stock returns, labor market frictions, firing costs, risk sharing, agency frictions

JEL Classification: G12, J38, G38