Employment Protection Laws and Corporate Cash Holdings

Research output: Contribution to journalArticle (Academic Journal)

Abstract

We study how employment protection laws (EPLs) affect corporate cash-holding decision. By exploiting within-country changes in EPLs across 20 OECD countries as a source of variation in labor adjustment costs, we show that following an increase in the stringency of EPLs, firms’ cash holdings increase significantly. This relationship is stronger for firms with high labor turnover, no multinational presence, or financial constraints, indicating that labor adjustment cost raising distress risk is the mechanism in play. Cash buffers created by firms faced with stricter EPLs help them mitigate the underinvestment problem in subsequent episodes of industry-wide distress. Consistent with this precautionary motive, the market's valuation of excess cash is positively associated with the EPL strictness. We further demonstrate that the response of cash policy to changes in EPLs is distinct from that of debt policy or investment policy. Our evidence highlights the role of interaction between labor-market and financial frictions in determining the level and the value of corporate cash.
Original languageEnglish
Article number105705
Number of pages19
JournalJournal of Banking and Finance
Volume111
Early online date21 Nov 2019
DOIs
Publication statusPublished - 1 Feb 2020

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Keywords

  • Employment protection
  • Labor adjustment cost
  • Cash holdings
  • Value of cash

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