Employment protection, corporate governance, and labor productivity around the World

Abstract

Consistent with the existing evidence from single-country studies, our difference-in-differences estimation finds a negative effect of employment protection legislation (EPL) provisions on labor productivity in a sample of member countries of the Organization for Economic Co-operation and Development (OECD). Our study is distinct, however, in that we provide empirical evidence on why EPL reduces labor productivity, which has different practical implications. The negative effect is more pronounced among firms domiciled in countries with weaker investor protection, less developed takeover markets, and weaker employee incentives to work hard, those in industries with less intense competition, those that suffer from more severe agency problems, and those that have lower pay-for-performance sensitivity. These results suggest that the firm-employee agency conflict is the channel through which employment protection legislation reduces labor productivity.