Labor Protections, Ownership Concentration, and Equity Risk: International Evidence from Cost of Equity Capital

Abstract

In this study, we investigate whether the labor protection regulations are systematically related to firms’ equity risk in an international setting. We argue that labor protections which constrain firms operating flexibility increase equity risk, hence the implied cost of equity. Our empirical 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 effect of labor protections 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 0.776% in widely held firms, while it increases by only 0.415% in firms with controlling shareholders. The empirical results further demonstrate that the increased cost of equity due to labor protections is acerbated in labor intensive industries. Our study sheds light on the equity risk induced by tight labor regulations.