Abstract
This paper examines how employment protection affects a firm’s ability to adjust resources and in turn, the persistence of firm performance. Using staggered adoptions of employment protection laws by U.S. state courts, we find that increasing employment protection reduces the extent to which firms can adjust the number of employees and capital investment in response to negative firm performance and industry upturn. We also find slower mean reversion in performance for underperforming firms while downward reversion is accelerated for overperforming firms. The negative effects are also highly asymmetrical, penalizing more heavily firms operating in industries with low elasticity of labor-capital substitution, firms with low financial slack, and when the majority of a firm’s competitors are not subjected to the same constraint.
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