Conflict of Interest between Labor and Controlling Shareholders: International Evidence from the Cost of Equity Capital

Abstract

In this study, we examine international differences in firms’ cost of equity capital around the world. Specifically, we investigate whether the effectiveness of labor protection regulations is systematically related to firms’ cost of equity capital and how the presence of controlling shareholders affects the relationship between labor protection institutions and the cost of equity. Our analysis exploits cross-sectional variations in labor market regulations, employment laws, and social security laws. Both firm- and country-level analyses reveal that firms in countries where labor rights are well protected have a significantly higher equity cost, after controlling for investor protection environments and firm- and country-level risk factors. However, the positive effect of labor regulations on the equity cost is significantly mitigated in the presence of controlling shareholders, especially in the case of a family controlling owner. The economic magnitude of such effect is substantial: a one-unit increase in labor market regulation index increases the annual cost of equity by 0.713% in widely held firms, while it increases by only 0.352% in firms with controlling shareholders. Our evidence sheds light on the role of labor regulations in shaping the corporate governance structure and the conflict of interest between employees and controlling shareholders.