Employee Satisfaction, Labor Protection, and Firm Leverage Around the World

This paper studies the effect of labor protection on the relation between employee satisfaction and firm capital structure across 32 countries. The stakeholder theory of capital structure states that firms whose values are derived largely from their human capital tend to maintain a lower debt ratio in an effort to reduce the indirect bankruptcy costs that arise from employees’ concerns over the risk of unemployment. We find that this employee-leverage relation critically depends on the labor market institution. The relation tends to be negative for countries with flexible labor markets and insignificant or even positive for countries with strong labor protections. These results are consistent with the notion that strong labor market protection is able to mitigate the employees’ concerns over firms’ changes in incentive and/or ability to offer job security and satisfaction. We also show that the individual-level protections matter more on the relation than the collective-level protections, and the relation is salient for the regulations on both regular and temporary contracts. Our results also shed light on the debate between the stakeholder theory and the crowding-out hypothesis with regard to the direct relation between labor protection and firm leverage