labor and strongfinancestrong - london business school.pdfVIP

Labor and Finance* Marco Pagano Università di Napoli Federico II, CSEF, EIEF and CEPR Paolo Volpin London Business School, ECGI and CEPR 14 June 2008 Preliminary and incomplete draft Abstract This paper overviews the growing literature on the effects of finance on labor. At their best, financial markets allocate resources efficiently, expanding output, investment and employment but also forcing inefficient firms to shut down or restructure. This second effect creates employment risk and costly reallocations. At firm level, this risk is mitigated by long-term employment relationships based on explicit and implicit contracts; at the macroeconomic level, it is contained via regulations and social norms. These are beneficial insofar as they improve risk sharing and encourage investment in firm-specific human capital, but may also allow managers and workers to entrench themselves and extract rents at the expenses of investors. Regulation, technological change and international trade openness affect the balance between the bright and the dark side of employment relationships. Keywords: labor, corporate finance, manager, trade union, ESOP, alliance, employment protection laws, investor protection laws. JEL classification: G34, K22, K42. * Paper prepared for the conference on “Labor, Law, Politics and Finance” organized by the Korea Money and Finance Association (KMFA) on 20 June 2008. We thank Han Kim for valuable comments. 1. Introduction A few years ago, the typical financial econo