The Labor Effects of Pro-labor Bias in Bankruptcy

Judicial decisions in bankruptcy are often influenced by the goal to preserve employment in financially distressed firms. What are the effects of these pro-labor decisions on workers' earnings and employment trajectories? We construct a new court-level measure of pro-labor bias based on the text of judicial decisions and exploit the random assignment of cases to courts within judicial districts in the state of Sao Paulo in Brazil to study the effect of pro-labor bias on labor market outcomes. We find that workers of firms assigned to high-pro-labor courts experience 4.4% lower post-bankruptcy earnings. This negative effect is primarily driven by wage adjustment rather than the probability of employment, and it is persistent in the five-year period after bankruptcy. We discuss several mechanisms that can drive this result.