Local government debt and corporate labor decisions: Evidence from China

This study investigates the effect of government debt on firm's labor adjustment decisions. By analyzing Chinese local government debt (LGD) data, we find that when LGD is higher, local firms exhibit greater labor cost stickiness. We attribute this to the responsibility-shifting effect, i.e., heavier debt burdens prompt local governments to intervene more in corporate labor decisions, particularly by limiting corporate employee layoffs. The effect is more pronounced for state-owned and politically connected firms; in regions with lower marketization levels and fiscal self-sufficient capacities; and when regional unemployment rates, macroeconomic uncertainty, and political risk are higher. Through responsibility-shifting amid high LGDs, local governments benefit from a reduction in social expenditure. However, firms with stickier labor costs have poorer employee welfare, lower productivity, and reduced market value, despite receiving more government subsidies. Our findings suggest that high LGDs not only adversely impact firm financing through the crowding-out effect but also erode firm value through the responsibility-shifting effect.