How does labor protection influence corporate risk-taking? Evidence from China

Abstract Considering the enforcement of China's Labor Contract Law as an exogenous event, this paper studies the relationship between labor protection and corporate risk-taking. We document a significant negative effect of labor protection on firms' risk choices. The effect is robust after considering several events, including the global financial crisis. After the law was implemented, firms tend to reduce leverage and intangible assets and increase cash holdings. We propose two potential channels for such an effect, reducing firms' operating flexibility and tightening their financial constraints. We also find that the negative impact is more pronounced for firms of lower governance quality. On the cross-section, state ownership and regional and cultural variations also influence the effect of labor protection on risk-taking. Our study sheds light on how government intervention (in addition to corporate law) shapes corporate policies, thus expanding and supplementing the existing literature.