Temporary Employment Legislation and Capital Structure

Abstract

In this paper, we examine the effect of changes in temporary employment legislation on leverage for Norwegian firms in the period 1997-2013. Adopting a difference-indifferences research design, in which we use labor intensity as an indicator of treatment, we find robust evidence that firms decrease their use of leverage following more stringent temporary employment legislation. Our explanation of these findings is that stringent temporary employment legislation makes labor cost more rigid in nature, which in turn increases financial distress cost and the likelihood of underinvestment, each of which are associated with reductions in leverage. Lastly, we find that small firms reduce their leverage ratios by more in response to more stringent temporary employment legislation, which can be explained by a greater sensitivity to increasing financial distress cost.