Employment Protection and VC Investment: The Impact of Wrongful Discharge Laws

Abstract

Wrongful discharge laws (WDLs) provide limits to the employment-at-will doctrine, and thus impair operating flexibility, increasing expected financial distress costs by making it costly to fire employees. This impairment is detrimental to start-ups, leading to a decline in venture capital (VC) investment. Using a difference-in-differences framework enabled by the staggered adoption of WDLs across the U.S. states, we show VC investment declines after a state adopts the Good Faith exception (the strongest form of WDL). This decline is most pronounced in sectors with high labor dependency.

Keywords: Wrongful discharge laws; venture capital; difference-in-differences

JEL Classification: G24; J30; K12