Employment Protection and Financial Reporting Quality

Abstract

We exploit the staggered state adoptions of wrongful discharge laws (WDLs) in the United States to study the effect of employment protection on financial reporting quality. Since rank-and-file employees are directly involved in a firm's daily operations, they are capable of identifying abnormal transactions. With greater employment protection, employees are less susceptible to managerial pressure and more likely to report these abnormal activities, which ultimately improves financial reporting quality. Using a generalized difference-in-differences model, we find that treatment firms, relative to control firms, increase their financial reporting quality after the adoption of WDLs. The improvement in financial reporting quality is greater for firms that are more affected by employment protection laws. Our study offers novel insights into the causal effect of employment protection, a form of employee-related ESG policy, on financial reporting quality.