Penalizing the Underdogs? Employment Protection and the Competitive Dynamics of Firm Innovation

This study examines how constraining a firm’s ability to adjust resources affects innovation and underscores a firm’s competitive position as a critical contingency to the competing demands for flexibility and efficiency. In response to losing competitiveness, lagging firms must release obsolete resources and increase experimentation with new resources. Limiting the pace and efficiency at which they can do so impedes their ability to innovate and challenge leading firms. I explore these ideas empirically by exploiting the staggered adoption of employment protection laws. Employment protection indeed reduces innovation by lagging firms, driven by a decrease in radical innovations. In contrast, I find a small yet positive effect on leading firms in low-velocity sectors, which prioritize the efficient use of existing resources. This study extends the prior contingency approach based on industry and task characteristics to incorporate a firm’s competitive position and provides a much more dynamic account of when and how firms experiment with new inventors, resources, and radical innovations.