Risk Sharing Within and Outside the Firm: The Disparate Effects of Employment Protection on Expected Stock Returns

Authors: Rüdiger Weber (WU) and Robert Mahlstedt (U of Copenhagen)

Title: Risk Sharing Within and Outside the Firm: The Disparate Effects of Employment Protection on Expected Stock Returns

Abstract: We study the effect of wrongful-discharge laws (WDL) on firm-level risk sharing and stock returns. We find disparate effects depending on the design of the law. Consistent with rational, risk-based pricing, the effect on returns is linked to how firms and workers share systematic risk under the respective laws. Firms in states with WDLs prohibiting employers from acting in bad faith have more intra-firm risk sharing, i.e. workers bear more risk and expected returns are lower. Vaguer legislation prohibiting discharges in retaliation for acting in accordance with public policy is associated with less intra-firm risk sharing and higher expected returns.