Labor Protection, Social Insurance Pressure and Corporate Default Risk: Evidence from the “Social Insurance Law” in China
XU Hongmei, LI Chuntao
International Business College, South China Normal University; School of Economics, Henan University; School of Finance, Zhongnan University of Economics and Law
Summary:
Due to the dire impact of the financial crisis and mounting downward economic pressure, Chinese academics and practitioners have recently shown great interest in corporate default, as it is among the most disruptive events in the life of a corporation. However, few studies have examined whether labor markets affect the likelihood of corporate default. Thus, we study the effect of labor protection on default risk. Labor protection can affect default risk for a number of reasons. On the one hand, it may affect firms' likelihood of default via the cost effect or the bargaining effect. Labor protection can increase labor costs, which increase firms' operation leverage. Consequently, firms' default risk may increase with greater operational pressure. On the other hand, firms with a higher likelihood of default tend to fire employees or cut off their welfare to lower costs. Thus, rational employees ask for higher wage premiums to hedge the risk of being fired or receiving pay cuts. To pay lower wage premiums, firms tend to keep lower debt ratios to alleviate employees' concerns.However, with the improvement of labor protection, they would increase debt ratios to capture a larger share of the tax benefit of debt. Consequently, the increase in debt increases the default risk. In general, theoretically, labor protection may increase the likelihood of default. However, the channel through which labor protection affects default risk still requires empirical examination. In this paper, we use the Social Insurance Law issued in 2011 as an exogenous shock to investigate the relationship between labor protection and corporate default risk. We use the Social Insurance Law as the exogenous shock for two reasons. First, the issue of the Social Insurance Law is exogenous for listed firms in China. Furthermore, it requires firms to pay five social insurances for employees. Thus, social insurance fees paid by corporations can be regarded as quasi-tax payments, ensuring that the cost of social insurance is constantly reflected in firms' labor costs. Therefore, the Social Insurance Law increases labor costs significantly. Second, no other confounding events or laws affected labor costs and default risk in 2011, which helps build the casual relationship between labor protection and default risk. Following the literature on the real effect of labor protection, we use a standard difference-in-differences approach to investigate the relationship between labor protection and the likelihood of corporate default. Our results show that the default risk increases by 1.5%, which is significant at the 1% level, in labor-intensive firms (i.e., the treatment firms) compared with non-labor-intensive firms (i.e., the control firms) after the implementation of the Social Insurance Law. We find consistent results when using the ex-post default risk (Violate) and the probability of being an ST firm (ST) as proxies for the likelihood of default. The mechanism test shows that the cost effect caused by labor protection mainly affects corporate default risk by increasing firms' operational leverage. Furthermore, the cross-sectional tests demonstrate that the positive relationship between labor protection and default risk is more pronounced for state-owned firms, more financially constrained firms, lower transparency firms, and innovative firms. We make multiple contributions. First, we contribute to the literature on the real effects of labor protection laws. The literature has found the Labor Contract Law in China to have either positive effects (e.g., promoting employment and innovation) or negative effects (e.g., reducing business flexibility and operating efficiency). We provide evidence that the Social Insurance Law increases firms' likelihood of default by boosting labor costs. Thus, our results provide new empirical evidence for evaluating the policy consequences of the Social Insurance Law. Second, we extend the research investigating the factors that affect corporate default risk. We contribute to this stream of literature by providing evidence that labor markets also affect firms' likelihood of default via increased labor costs. Finally, our results indicate that the government should lower the social insurance rate if it conducts more stringent social insurance fee collection arrangements. Otherwise, it may increase corporations' default risk by boosting labor costs.Our research also provides some insights to governments' tax and social insurance fee reduction schemes during the period of the novel coronavirus pneumonia outbreak.
许红梅, 李春涛. 劳动保护、社保压力与企业违约风险——基于《社会保险法》实施的研究[J]. 金融研究, 2020, 477(3): 115-133.
XU Hongmei, LI Chuntao. Labor Protection, Social Insurance Pressure and Corporate Default Risk: Evidence from the “Social Insurance Law” in China. Journal of Financial Research, 2020, 477(3): 115-133.
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