Unemployment Insurance and Financial Leverage of Firms
PENG Zhang, SHI Xinzheng, LU Yao, WANG Hao
School of Public Finance and Taxation, Central University of Finance and Economics; School of Economics and Management, Tsinghua University; Bain & Company
Summary:
The increasingly marketized labor market in China leads to more frequent job-hopping, imposing higher unemployment risk on employees. This trend makes unemployment insurance more and more important. Unemployment insurance is a crucial labor protection policy. It provides unemployed people with the means to meet their basic needs and keeps society fair and stable. Although unemployment insurance is a positive benefit for individual employees and society, how it affects employers is still unclear. We investigate the impact of unemployment insurance on firms' financial leverage. Recent studies show that labor and leverage are closely related, but most of these studies focus on U.S. firms. The labor market in the U.S. is quite different from that in China. How labor factors affect firms' leverage in China is still unclear. In theory, unemployment insurance can have both positive and negative impacts on leverage. First, increases in unemployment insurance may lead to lower leverage. As higher unemployment insurance can compensate employees when they lose their jobs, the employees are less sensitive to unemployment risk, thus they require less risk premium and firms' labor costs are reduced. When firms have more free cash flows and revenue, they may use internal funding to replace debt financing and even repay debt, which leads to lower levels of leverage. We call this channel the “labor cost channel.” Second, higher unemployment insurance lead to fewer labor costs. Most labor costs are fixed costs, so lower labor costs result in lower operating leverage. The managers can choose higher financial leverage when the operating leverage decreases, thus leading to a positive relationship between unemployment insurance and financial leverage. We call this channel the “operating leverage channel”. Third, Agrawal and Matsa (2013) find that firms' conservative financial policies can partially eliminate employees' unemployment risk. When unemployment insurance increase, employees are more tolerant of unemployment risk, so firms can take higher leverage. We call this channel the “bargaining channel”. Using Chinese public firms' data from 2009 to 2019, we find that a 1% increase in unemployment insurance, on average, leads to a 0.021～0.38 percent point decrease in firms' financial leverage. Then, we test the labor cost channel. We find that unemployment insurance are negatively related to employees' wages, especially non-executive employees' wages. Lower employees' wages are associated with lower leverage, less debt financing, more internal financing, and a higher probability of repaying debt. These results are consistent with the labor cost channel. Further tests show that this effect is more pronounced in provinces with high unemployment rates because the employees in these areas are under larger unemployment risk; this effect is also more pronounced in SOEs because the overindebtedness problem is severe in SOEs. We also find that unemployment insurance have a significant negative impact on firms' long-term debt ratio but no impact on their short-term debt ratio. We conduct several robustness checks. First, to address the potential endogeneity problem, we respectively use the Social Insurance Law enacted in 2011 and the Guidance on Adjusting Unemployment Insurance Standard enacted in 2017 as natural experiments and conduct both difference-in-differences estimations and instrumental variable regressions. All of the results are consistent with the main result. Then, we address the multicollinearity problem caused by the high correlation between unemploymentand minimum wages. Moreover, we try alternative specifications, address the potential impact of investment, and use alternative sample periods. The main result holds for all of these robustness tests. We make the following contributions to the literature. First, we contribute to the understanding of Chinese labor and finance. The labor and finance literature has recently attracted scholarly attention, but few studies use Chinese data. We fill this gap. Second, we contribute to the research on Chinese unemployment insurance policies. Most current papers on unemployment insurance policies are from the perspectives of individuals, industries, or regions. In contrast, we investigate unemployment insurance from the firm's perspective. Third, our findings add to the literature on capital structure. This paper has implications for policy makers. Our results suggest that higher unemployment insurancecan lower firms' leverage, indicating that more supportive unemployment insurance policies not only benefit employees but also firms and society.
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