Why employment laws can hurt smaller firms

Laws that protect employees from dismissal can benefit workers, but new research from Duke University’s Fuqua School of Business suggests that in developed markets, those same laws can put smaller firms at a competitive disadvantage.

Professor Sharon Belenzon found firms in corporate affiliate groups — sets of companies with the same owner — outperform their standalone competitors in countries with tougher employee protections, because of their ability to move workers between companies without falling afoul of the rules.

With Ph.D. student Ulya Tsolmon, Belenzon studied more than 68,000 firms across Western Europe in industries ranging from clothing stores and transportation services to publishing and paper production. Their findings, “Market Frictions and the Competitive Advantage of Internal Labor Markets“, were published this month in the Strategic Management Journal.

“Europe is a great place to study because of the variation of employment policies and the financial development of the stock market and banking system,” Belenzon said. “The countries are comparable, but different.”

The researchers examined industry turnover, company affiliation and performance, and the level of financial development in each country, measured by the value of its stock market relative to its gross domestic product. About 40 percent of firms in Europe belong to a corporate group of two or more firms owned by the same entity, Belenzon said.

“We found disproportionately more group affiliates in countries where employment protection laws are stronger, especially in industries that need to adjust labor frequently,” he said.

Belenzon said the larger firms — those in groups — benefit from being able to move workers between companies while remaining in compliance with the law.

“Because they are very big, if they need to adjust they don’t have to fire people, they can just move them to another part of the organization. This movement is not subject to employment protection laws,” Belenzon said. “But if small firms want to adjust labor they have to do it using the market. If you are a small firm and you are moving the same kind of employee to a different firm that is not part of the same corporate group, then you are penalized — and the penalties can be extremely severe. It gives a big advantage to corporate groups.”

In the UK, which had the weakest employment laws of the countries studied, group-affiliated companies grew 29 percent faster than standalone companies between 2007 and 2011, the researchers found. In Greece, where the employment laws were strongest, the group-affiliated firms grew 48 percent faster than standalones in the same span.

Belenzon said this effect is especially pronounced in countries with more developed financial systems. The U.S. has one of the most highly developed financial systems in the world, but some of the weakest employment protection laws. Any effort to change that, Belenzon said, would have consequences.

“A conclusion of this paper is that if we impose any restrictions on the ability of companies to hire and fire workers in the U.S.,” he said, “large firms will disproportionately benefit.”

This article is published in collaboration with Duke. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Gregory Phillips writes for Duke University. Erin Medlyn writes for Duke University. 

 Image: Pedestrians cross a road at Tokyo’s business district September 30, 2014. REUTERS/Yuya Shino