Employee Protection and Earnings Opacity

• In Event: Culture and Institutional Influences

Abstract

Using country-level employment protection legislations as exogenous changes in labor power, this study examines the role of employees as an important stakeholder in influencing corporate financial reporting. We find that strengthened employment protection legislations (EPL) significantly increases firms’ earnings opacity. The positive effect of EPL on earnings opacity is significantly stronger when employees gain more power to expropriate firm rents, but is attenuated when managerial incentives are more aligned with those of shareholders. Further analysis indicates that the EPL-triggered earnings opacity correlates positively with employee compensation, but negatively with labor productivity, firm performance, and shareholder value. These findings are consistent with the view that strong EPLs are conducive to a management-employee alliance, wherein managers reporting more opaque earnings to facilitate and conceal their collective rent extraction at the shareholders’ expense. This paper contributes to the literature by demonstrating how a corporate governance structure, built on balancing interests among different stakeholders rather than exclusively on maximizing shareholder benefits, shapes financial reporting in the international markets.

Authors

• Re-Jin Guo, University of Illinois at Chicago

• Inder K Khurana, University of Missouri-Columbia

• Rong(Irene) Zhong, University of Illinois at Chicago