Employee Board Representation and Capital Investment

We examine how parity employee representation (PER) on corporate boards affects firms’ capital investments. In Germany, PER is legally mandated for firms with more than 2,000 domestic employees, but not for those below this threshold. Exploiting this discontinuity, we show that PER has heterogeneous effects on firms operating in diverse environments. For firms experiencing positive growth, PER increases their responsiveness to investment opportunities, suggesting that employee participation increases firms’ ability to exploit growth options. The effect through growth options is particularly salient in situations in which growth options are highly valuable. In contrast, for firms experiencing negative growth, PER reduces investment responsiveness, suggesting that employees resist the exercise of abandonment options. This effect is more pronounced in firms with high labor intensity, in which employees are likely to have a strong voice. Furthermore, operational risk moderates the effects of employee representation––the positive effect through growth options is attenuated in high-risk firms and the negative effect through abandonment options is exacerbated, thereby suggesting that employee board representatives are less interested in pursuing growth where businesses are relatively risky, and they protect their constituents more forcefully in high-risk environments. Moreover, the positive effect of PER on exploiting growth options is attenuated by collective bargaining agreements, while its effect through abandonment options is little affected. Evidence from stock price behavior further supports the viewpoint that employee representation affects capital investment. Our findings are relevant to policymakers as well as to firms’ various stakeholders. This paper was accepted by Eric So, accounting. Funding: This work was supported by China’s National Science Foundation [Grants 72032003, 72102166]; China’s Ministry of Education [111 Project (B18033)]; and China’s Ministry of Education (Project of Key Research Institutes of Humanities and Social Science in Universities [22JJD790094]). Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.03495 .