This paper uses …rm-level data from 21 countries over the 1985-2004 period to examine the e¤ect of labor regulation on the equilibrium choice of debt by …rms. We …nd that increases in labor protection are associated with decreases in the use of debt by …rms. We interpret this result as evidence that operating leverage (in the form of higher labor costs) crowds out …nancial leverage. Furthermore, we …nd that the e¤ect of employment protection is more pronounced for …rms that rely more on labor and have lower liquidation value, and in countries where bargaining is more decentralized. Our results are robust to changes in empirical speci…cations, including di¤erent de…nitions of leverage and a di¤erences-in-di¤erences approach that exploits inter-temporal variations in labor laws across countries
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