JFE special issue on labor and finance

Abstract

We investigate the impact of stock market liberalization on firms' labor investment decisions. Exploiting the Mainland-Hong Kong Stock Connect program as an exogenous shock and employing a staggered difference-in-differences approach with a sample of 1938 Chinese listed firms from 2010 to 2020, we find that stock market liberalization enhances labor investment efficiency by correcting both under-investment and over-investment in labors. This main effect remains robust after addressing endogeneity concerns, using alternative samples and different proxies for labor investment efficiency, and the consideration of non-labor investments. Improved stock liquidity and a more transparent information environment, which strengthen market participants' external monitoring, are the two key channels driving these improvements. Cross-sectional analyses indicate that the effect is stronger for non-state-owned enterprises (non-SOEs). Taking a broad view of labor investments, we find that stock market liberalization also fosters more employee-friendly practices through better wages and welfare. Overall, this study underscores the significant role of nationwide financial reform in shaping firms' labor investment decisions.