When labor protection hurts to help: Evidence from zombie firm exits

• This paper examines how employment protection affects zombie survival. • Increased employment protection legislation reduces the prevalence of zombie firms. • Stricter EPL lowers recovery probability and accelerates zombie firm exit. • Zombie firms shift from layoffs to fixed asset sales after EPL reforms. This study exploits increases in the stringency of the employment protection legislation (EPL) index as a quasi-exogenous shock to examine the causal effect of labor market regulations on the prevalence of zombie firms. Stricter EPL restricts layoffs, thereby reducing the probability of recovery and indirectly weakening creditors’ incentives to gamble on firm revival. Moreover, EPL reforms accelerate the market exit of zombie firms. Following these reforms, zombie firms are also more likely to engage in fixed asset sales rather than workforce reductions as a restructuring strategy.