Wrongful Discharge Laws and Innovation

We show that wrongful discharge laws - laws that protect employees against unjust dismissal - spur innovation and new firm creation. Wrongful discharge laws, particularly those that prohibit employers from acting in bad faith ex-post, limit employers' ability to hold up innovating employees after the innovation is successful. By reducing the possibility of the hold-up, these laws enhance employees' innovative efforts and encourage firms to invest in risky, but potentially mold-breaking, projects. We develop a model and provide supporting empirical evidence of this effect using the staggered adoption of wrongful discharge laws across the U.S. states.