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H»'" HHBji Digitized by the Internet Archive in 2011 with funding from Boston Library Consortium Member Libraries http://www.archive.org/details/costsofwrongfuldOOauto HB31 .M415 oi- |J>< Ml Massachusetts Institute ofTechnology Department ofEconomics Working Paper Series THE COSTS OF WRONGFUL-DISCHARGE LAWS David H. Autor John Donohue J. III Stewart Schwab J. Working Paper 02-41 November 18,2002 Room E52-251 50 Memorial Drive MA Cambridge, 02142 This paper can be downloaded without charge from the Social Science Research Network Paper Collection at http://papers.ssrn.com/abstract=355861 1 The Costs ofWrongful-DischargeLaws David H. Autor MIT Department ofEconomics and NBER John J. Donohue III Stanford Law School and NBER Stewart J. Schwab* Cornell Law School November 18, 2002 Revised from July 200 Abstract We estimate the effects on employment andwages ofwrongful-discharge protections in the United States. Overthe last three decades, mostU.S. state courts have adopted one ormore common law wrongful- discharge doctrines that limit employers' discretion to terminate workersat-will. Using this cross-state variation with a difference-in-difference framework, we find robust evidence ofa modestnegative impact (-0.8to -1.6 percentage points) ofone wrongful-discharge doctrine, the implied-contract exception, on employment topopulation rates in state labormarkets. The short-term impact is mostpronounced for female, younger, and less-skilledworkers, while the longerterm costs appearto be bome by olderand more-educatedworkers- those most likely to litigate underthis doctrine. We find no robust employment or wage effects oftwo otherwidely recognized wrongful-discharge laws: the public-policy and good-faith exceptions. Published findings in the literaturerange from no effect to very largenegative effects. We reanalyze the two leadingstudies and find the discrepancies can be explainedbymethodological shortcomings in the one case and limitations in the coding ofkey court decisions in the other. Weareindebted to Joshua Angrist, David Card, Lawrence Katz, Alan Krueger, Thomas Miles, AndrewMorriss and seminarparticipants atthe NBER Labor Studies Summer Institute, UC Berkeley,NYU Law School, Stanford Law School, andthe American Law and Economics Association forexcellent suggestions. Wegratefully acknowledgethe excellentresearch assistanceofRashidaAdams, Michael Anderson, SimoneBerkowitz, Sarah Bernett, Douglas Bosley, Craig Estes, Rose Francis, ScottHemphill, Carolyn Heyman, Joshua Linn, JoshuaMayes, Marci Reichbach, andLeslie West, andtheresearch coordination ofRoseMerendino. What is the price ofprotection? Thispaper estimates the social costs, in terms ofpotentially lower employment and wages, ofcommon law efforts to protect American workers from wrongful-discharge. The cost ofemploymentprotection is a controversial issue. It is virtually received wisdom that the stagnant employmentperformance ofmany European economies during the 1980s and 1990s- 'Eurosclerosis' -can be attributed to the significant employmentprotection given European workers (cf, Lazear, 1991; Blanchard and Wolfers, 1999). According to this argument, employmentprotection is a double-edged sword. Itprovides employment security to incumbent workers butmakes employersreluctant to hire, leading to a stagnant labormarket withpotentially lower employment and wage levels. Among the obstacles totestingthis hypothesis is the difficulty in obtaininghigh quality data for cross-country comparisons. In this paper, we study the impacts ofemployment protection in the U.S. setting. Several scholars have examined the effects ofAmerican federal employment laws on employment andunemployment. Acemoglu andAngrist (2001) andDeLeire (2000)present evidence that the Americans with Disabilities Act decreased employment ofdisabledpersons. Oyerand Schaefer (2000, 2002) conclude that the federal Civil Rights Act of 1991 increasedthe frequency ofmass layoffs andraised the returns to experienceforworkers whohave a downward sloping 'age-litigation' profile. Harm, Todd, and van derKlaauw (2001) also evaluatethe costs A offederal anti-discrimination laws. majorhurdle for eachofthese studies is thatthe federal statutes at issue apply all at once to the entire country. It is difficultto separate the effects ofthe statute from all other changes occurring at thattime (cf, Donohue, 1998; Donohue and Heckman, 1991). Thispaper overcomes some ofthese methodological challenges by evaluating employmentprotections that arise in various U.S. states atvarious times, thus providing greatervariation with whichto more accurately establish causal relationships. The United States, uniquely in the industrialized world, has long had a legal presumption that workers can be fired "atwill"- that is, for any time and foranyreason, good orbad. In the last two to three decades, however, most state courts have adopted one ormore common law 'wrongful-discharge' protectionsthat weaken the employment-at-will presumption. States vary greatly in the timing and extent oftheir recognition ofthese wrongful-discharge laws. Three states- Florida, Georgia, 1 and Rhode Island - haveneveraltered the employment at will doctrine. Ten states now recognize each of three broad classes ofexception to the at-will doctrine the Implied-contract, Public-policy, and Good-faith : exceptions (theirprecise meaning is defined below). A few states have rejected prior adoptions(see Appendix Table 1). This variability in the extent and timing ofstates' recognition ofwrongful-discharge laws allows for empirical testing oftheir impacts on employment and wages. We are not the first to explore these effects. In a widely cited line ofresearch, Dertouzos andKaroly (1992 and 1993) used an instrumental variables framework to testwhetherwrongful-discharge laws affected state-level employment. They found surprisingly large impacts. Dertouzos and Karoly estimate that states adopting a tort-based cause ofaction (that is, one inwhichplaintiffsmay sue employers forpunitive damages) suffered a 3 percent reduction in aggregate state employment- roughly equivalentto a 10percent employer side tax on wages- with anadditional 1 or2 percent employment decline for states also adopting a contract-based protection (that is, one in which plaintiffs may sue only for economic losses).2 These findings have not gone unchallenged. Morriss (1995) criticized Dertouzos and Karoly's legal variables. More recently, Thomas Miles (2000) used a differences-in-differences approach to estimate the impact of the wrongful-discharge doctrines. Hereports "no statistically significant effects on eitheremployment or unemployment," but does not comment on the source ofthe discrepancy between his findings and those of Dertouzos and Karoly.3 Ourpaperjoins this debate at twopoints. First, we provide a comprehensive reevaluation ofthe impacts 1 Todate, onlyMontana(in 1987)haspasseda statuteestablishingagood-cause standard forall employment terminations. All otheremploymentat will exceptionsare common lawdoctrines,i.e., caselaw. In 1991,theUniform LawCommissionersproposedaModel EmploymentTermination ActsimilartotheMontanastatute,butno statehas yetadoptedit. In 1996,theArizonalegislature passed a statute affirmingemploymentat will. Krueger(1991) provides aperceptive econometric studyoftheconsideration ofexceptionstothe doctrineofemploymentatwill bystate legislatures. 2 Dertouzos and Karoly (1988) earlierexaminedthe directcosts ofwrongful-dischargelitigation in California. They foundthesedirect coststobe modest, amountingto some $100pertermination. See alsoDertouzos and Karoly(1992; p. xi) (presenting findings of1988 study). 3 In related work, Kuglerand Saint-Paul (forthcoming) findthat a state'sadoption ofwrongful-discharge doctrines significantlyslowsthejob-to-jobflows ofunemployed relativetoemployed workers. Autor(2003 forthcoming)and Miles(2000) findthat employersincreased demand fortemporaryhelpagency employmentwhenstates adopted common law exceptionsto employment atwill. ofwrongful-discharge doctrines on employment and wages using richer data and (we believe) a more complete coding ofthe case lawthanpreviouswork. Second, we evaluate whythe leading papers on this topic havereached opposing conclusions - ranging from no effect to very large negative effects- and provide a reconciliation ofthese findings. As with the Miles and Dertouzos andKaroly studies, ourkey explanatory variables are the precedent We setting cases that establish the wrongful-discharge laws recognized in each state and time period. differ from previous studies, however, byusing legal and employment data observed at monthly intervals, by measuringwage as well as employment impacts, andby exploring these impacts separately by education We and gender demographic subgroups overthenearand longerterm. apply robust estimationtechniques throughoutand testthe consistency and generality ofour findings across specifications and timeperiods. Althoughwehad anticipated that ourreanalysis would reconfirm the null hypothesis accepted by Thomas Miles, we instead find amodestbutrobustly negative impactofone wrongful-discharge doctrine- the Implied-contractexception - on the employmentto population rate in state labormarkets. This impact, which averages-0.8to-1.6 percent, is present for al education and gender groups, and is detectable among states adopting at several time intervals duringthe sample. The short term impact is mostpronounced for females, and younger andless-educatedworkers. In the long term, however, the costs ofimplied-contract protection appearto be borne by olderandmore-educatedworkers -those most likely to litigate. We also find some evidence thatthe Good-faith exception reduced state employment levels by a similar magnitude, but this evidence is farless robust. Finally, we findthat both doctrines (Implied-contractand Good-faith) have aweaklypositiveassociation with wages- that is, observed wages ofemployed workers tendtorise by 0.5 to 1.5 percentage points afteradoption ofthese doctrines. One interpretation ofthis finding is that employmentprotection strengthens workerbargainingpower, leading to higher wages and lower employment levels (cf., Blanchard and Portugal, 2000). However, amore parsimonious explanation thatwe favor- andprovide some evidence to support) - is that the negative employment impacts ofthe wrongful-discharge laws are borne by the lowest-wage workers within given demographic groups, leading to an upward composition bias in observed wages. 3 To reconcile the substantial discrepancies between our findings and the prior literature, wereanalyze the work ofDertouzos and Karoly (1992) and Miles (2000). We find that the exceedingly large disemployment effects estimatedbyDertouzos andKaroly - three to five times the magnitude ofour estimates -appear driven byproblematic instrumental variables that are spuriously correlated with regional employment trends that substantiallypredate states' adoption ofwrongful-discharge laws. By contrast, the differences between our findings and those ofthe methodologically similar Miles's study are primarily explained by discrepancies in the coding ofkey court cases. By making warranted modificationsto these analyses, we demonstrate thatthese priorresults may be reconciledwith ourown. Wrongful-discharge laws I. A. Commonlawexceptionstoemploymentatwill:Definitionandlegalsignificance Since the heyday ofemployment at will in the earlypart ofthe 20th century, legislatures and courtshave restricted employers' discretion to terminate workersat-will in several ways. Broad federal statutes prohibit employers from firing workers on the basis ofunion activity, race, color, religion, sex, national origin, age, or disability. Specific federal and state statutes prevent employers from terminatingworkers foravarietyof precisely defined impermissible reasons, such as to avoid pension benefits from accruing, or to retaliate because aworkerreported occupational safety and health violations orserved as ajuror.5 In addition to these statutory restrictions, state courts have overthe last 30 years substantially modified the employment at-will doctrine. These modifications, which wereferto as wrongful-discharge laws, are commonly classified in three categories: (1) the tort ofwrongful-discharge in violation ofpublic-policy ('Public-policy exception'); (2) the implied-in-fact contract not to terminate without good cause (Tmplied- contract exception'); and (3) the implied covenantto terminate only in good-faith and fair dealing ('Good- National Labor Relations Act § 8(a)(3), 29 U.S.C. §158(a)(3) (enacted 1935)(prohibiting discrimination onthebasis ofunion status);TitleVII ofthe Civil RightsActof1964,42 U.S.C. §§ 2000eto2000e-17 (prohibiting discrimination onthebasis ofrace, color, sex,religion, ornational origin); Age Discriminationin Employment Actof1967, 29 U.S.C. §§ 621-634;AmericanswithDisabilitiesActof1990,42U.S.C. §§ 12101 - 12213. Employee Retirement Income SecurityActof1974 § 510, 29U.S.C. § 1140 (prohibiting discrimination against employeesbecausetheymightobtainbenefits inapensionorwelfare plan); Occupational Safetyand HealthActof 1970 § 1 1, 29U.S.C. 660(c) (prohibiting discrimination against employees exercisingrights underOSHA); New York Judiciary Law § 519(prohibitingdischarge ofemployee dueto absence from employmentforjury service).