The Effect of Labour Protection Laws on the Relationship between Leverage and Wages

Abstract

Previous research has shown that leverage has a positive effect on wages. Using US state-level labour protection laws as an exogenous shock, we find that the adoption of the law alleviates the effect of leverage on wages. We show that the mitigating effect on the leverage-wage relationship is more pronounced for firms with strong employee bargaining power. Our study highlights the positive role played by labour protection laws in lowering firms’ labour costs and improving their financial flexibility, which complements the literature and advances our understanding of the broad implications of labour protection laws.

Keywords: Labuor protection, leverage, employee pay, bargaining power, capital structure

JEL Classification: G32, J31, J63, K31