Dissecting the Influence of Geopolitical Risks on Employment Decisions: The Role of Employment Protection Across Countries

Abstract

We investigate the impact of geopolitical risk (GPR) on corporate labor investment choices. We provide evidence that GPR significantly induces distortions in firms’ labor investment and is associated with higher deviations of labor investment from the optimal level justified by economic fundamentals, i.e., lower efficiency in their labor investment. Our further analyses indicate that this relationship is exacerbated in firms with high labor adjustment costs and severe financial constraints preventing firms from adjusting their labor freely. Additionally, we examine the moderating role of the country-level institutional environment of labor-friendliness, i.e., national employment protection, on the relationship between GPR and labor investment inefficiency. Our results suggest that stringent employment protection environments in terms of legal rigidity and enforcement prompt firms to engage in more conservative and risk-averse employment strategies by avoiding the costly costs of excessive employees when faced with elevated geopolitical uncertainty. Finally, we extend our investigation to the cyclicity of employment growth in relation to economic cycles and present evidence that GPR significantly increases the cyclicity of employment growth to economic booms and recessions whereas stricter employment protection makes this association less cyclical. Collectively, our study highlights the disruptive role of escalating geopolitical tensions in corporate employment decisions and underscores the critical role of EPL in cushioning firms against inefficient labor investment and tempering the cyclical volatility of employment in an era of ongoing tumultuous global challenges.

Keywords: Geopolitical risk, Human capital, Labor investment efficiency, Employment protection