Wrongful Discharge Laws and Innovation

Abstract

We show that wrongful discharge laws -laws that protect employees against unjust dismissal -spur innovation and new firm creation. Wrongful discharge laws, particularly those that prohibit employers from acting in bad faith ex post, limit employers' ability to hold up innovating employees after the innovation is successful. By reducing the possibility of hold-up, these laws enhance employees' innovative efforts and encourage firms to invest in risky, but potentially mould-breaking, projects. We develop a model and provide supporting empirical evidence of this effect using the staggered adoption of wrongful discharge laws across the U.S. states.

Maneuvering through Hostile Environments: How Firms Leverage Product and Process Innovativeness

“…The commonly held tenet is that regulation alters the competitive environment and leads to increased pressure to improve the production process through process innovativeness (Aghion, Bloom, Blundell, Griffith, & Howitt, 2005). For instance, Acharya, Baghai, and Subramanian (2014) argue that more stringent labor market regulations, such as unions or strict dismissal laws, can bolster employee knowledge by incentivizing employees to engage in training, therefore increasing motivation and productivity, which leads to greater and more significant process innovativeness. These observations suggest that process innovativeness is contingent upon regulatory pressures, thus associating higher levels of restrictiveness with greater process innovativeness (Barbosa & Faria, 2011;Blind, 2012).…”

Debt renegotiation under reputation concerns and tolerance for failure

“…In the context of regulatory response to banks managers that roll over bad loans, Rajan (1994) and Corbett and Mitchell (2000) capture the notion that managers must be rewarded in bankruptcy to reveal private information. More recently, Acharya et al (2014) show that if the law provides leniency in the case of failure, then we observe more entrepreneurial activities. Ederer and Manso (2013) also find experimental evidence that contracts that exhibit tolerance for short-term failure create incentives for successful innovation in the long term.…”

Collective Bargaining and Innovation in Germany: A Case of Cooperative Industrial Relations?

“…At this stage, Acharya, Baghai, and Subramanian (2012) introduce a wrongful discharge law that allows the fired employee legal recourse in the event that the innovation was successful. Even though the commitment problem is not eradicated, the law lowers the probability of employer malfeasance and increases employees' innovative efforts, thereby encouraging firms to invest in innovative projects.…”

“…7 Recent U.S. studies. Two studies not included in extant cross-country studies are those of Acharya, Baghai, and Subramanian (2012) and Bradley, Kim, and Tian (2015) for the United States. From the previous section it will be recalled that Acharya, Baghai, and Subramanian argued that wrongful discharge laws spur innovation in circumstances in which the employer and the employee cannot commit to a contract that prohibits either of them from acting in bad faith ex post.…”

“…The empirical model examined the before-and-after effect of a change in the law recognizing the good faith exception on innovative activity in affected states versus the before-and-after effect in states in which no such change was introduced. Acharya, Baghai, and Subramanian (2012) reported first that the adoption of the good-faith clause led to an increase in the annual number of patents (citations) of 12.2 (18.8) percent vis-a-vis firms in states which did not pass this law. Second, innovative effort as measured by patents (citations) scaled by the number of employees, or by R&D expenditure, increased materially with the adoption of the good-faith exception.…”