Labor Adjustment Costs and Risk Management

Abstract

This paper studies the effects of labor adjustment costs on corporate risk management. Labor adjustment costs attenuate the correlation between the internal funds of a firm and its investment opportunity, and create more incentives for the firm to smooth internal funds. Using a state border discontinuity approach, I find that state-level labor protection laws significantly impact a firm’s use of foreign currency derivative contracts. I further find that a firm holds more cash when labor adjustment costs are larger, and such an effect concentrates on firms that do not engage in derivative hedging.