The Regressive Effects of Worker Protection: The Role of Financial Constraints

Abstract: I exploit the staggered adoption of U.S. state-level Employment Protection Legislation (EPL) to study its effects on firm profits and the wage bill. I find that EPL has unintended regressive consequences. EPL harms smaller firms and their workers, while only benefiting larger firms and their workers. These effects operate through a credit channel: EPL limits access to credit for smaller firms, forcing them to cut employment and even exit the market. Conversely, larger firms expand employment by issuing more debt while benefiting from lower competition. A model with heterogeneous firms and endogenous financial constraints guides the empirical analysis.