Study suggests firms cluster together to navigate tight employment regulations

Groups of businesses lessen the impact of employment rights legislation by creating their own internal labour markets, new research from Bayes Business School suggests.

Academics analysed the impact of Spanish legislation which made it easier and cheaper for employers to fire workers. They found the change, implemented in 2012 to encourage job creation, triggered significantly more new jobs in stand-alone firms than in similar companies that were part of corporate group structures.. The gap was around 2.8 percentage points.

With access to their group’s internal labour market, the study concludes, firms that are part of corporate groups appear more likely to risk taking on additional workers – even when workers enjoy significant regulatory protection. Reforms to liberalise labour markets – such as those introduced in Spain in 2012 – are therefore less of a spur to job creation for these firms, the academics conclude.

Implications for UK government's employment rights package

Their findings also suggest that the UK government’s employment rights bill, which had its third reading in the Lords last week, will disproportionately affect standalone companies rather than those in groups.

Co-author Giacinta Cestone, Professor of Finance at Bayes Business School (part of City St George’s, University of London), explained: “Internal labour markets effectively give corporate groups a way to sidestep or soften the impact of strict employment laws. When those laws are relaxed, these advantages disappear, changing both firm performance and the overall structure of the corporate landscape. In Spain, the ability to navigate strict labour laws became less important after 2012, and so did the benefits of internal labour markets.”

The benefits of internal labour markets are particularly noticeable in corporate groups that own several firms in the same city. During downturns they are able to move workers around – and therefore avoid or limit redundancies. Similarly, affiliates operating in different sectors but with workers who have similar skills can cushion a downturn in one industry by redeploying employees.

Co-author Francisco Urzua, Professor of Finance at Bayes Business School, said: “When estimating the impact of labour market reforms, policymakers should take into account the prevalent ownership structures in the economy."

That is particularly relevant for European economies, where small and medium-sized enterprises are often group affiliated.

The group structure appears to lose some of its appeal when employment regulation is loosened. Spanish firms created after 2012 were 6 percentage points less likely to be part of a group structure than those formed before the regulatory change. Existing corporate groups slowed their rate of growth.

Jaijun Tao from the University of Leicester said: “This finding provides the first causal evidence for the oft-repeated claim that external labour market frictions are a key determinant of organisational structure and favour the emergence of corporate group structures. We have also confirmed that these employment effects were not down to so-called internal capital markets – which involve affiliates sharing financial support with troubled group members.”