Capital market frictions and human capital investment: Evidence from workplace safety around regulation SHO

• Author: John (Jianqiu) Bai,Eunju Lee,Chi Zhang
• Published date: 01 May 2020
• DOI: http://doi.org/10.1111/fire.12227
• Date: 01 May 2020

DOI: 10.1111/fire.12227

ORIGINAL ARTICLE

Capital market frictions and human capital

investment: Evidence from workplace safety

around regulation SHO

John (Jianqiu) Bai1Eunju Lee2Chi Zhang2

1Finance Group at D’Amore-McKimSchool of

Business, Northeastern University, Boston, MA

2Finance Department, Manning School of

Business, University of Massachusetts Lowell,

Lowell,MA

Correspondence

ChiZhang, Finance Department, Manning School

ofBusiness, University of Massachusetts Lowell,

Lowell,MA 01854.

Email:Chi_Zhang1@uml.edu

Abstract

This paper examines the effect of capital market frictions on firms’

workplace safety.Using Regulation SHO as a natural experiment, we

find a significant increase in work-related injury rates of pilot firms.

The effect is stronger for firms in more competitive industries and

with high financial constraints, and weaker for firms whose employ-

ees have high negotiating power and with good corporate gover-

nance. Furthertests suggest that managers’ myopia shifts their focus

away from investments in workplace safety when workplace safety

is not related to firm performance. Overall, the results highlight how

capital market frictions affect firms’ investmentin human capital.

KEYWORDS

managerial myopia,regulation SHO, short selling, workplace safety

JEL CLASSIFICATIONS

J28, G14, G18

1INTRODUCTION

The real impact of financial marketdevelopment on macroeconomic activities has drawn considerable academic atten-

tion from financial economists. Prior studies find that financial development leads to faster economic growth (Beck,

Levine, & Loayza, 2000; Jayaratne& Strahan, 1996; King & Levine, 1993; Levine & Zervos, 1998) and improves capi-

tal allocation (Rajan & Zingales, 1998; Wurgler,2000). More recent work shows that secondary financial markets also

influencemicrolevel decisions such as corporate investment (Bond, Edmans, & Goldstein, 2012). However,relatively lit-

tleis known about whether frictions in the capital market affect firms’ investment in human capital. This paper attempts

to shed light on this issue.

Human capital is becoming an increasingly important factor in the United States as the country transforms

into a more knowledge-based economy. The amount U.S. businesses spend on payroll dwarfs that spent on capital

expenditures($6.3 trillion vs $1.6 trillion), according to 2015 Statistics of U.S. Businesses.1One challenge for research

1https://www.census.gov/data/tables/2015/econ/susb/2015-susb-annual.html.See also the 2015 Annual Capital Expenditures Survey (https://www.census.

gov/library/publications/2017/econ/2015-aces-summary.html).

Financial Review.2020;55:339–360. wileyonlinelibrary.com/journal/fire c

2020 The Eastern Finance Association 339

340 BAI ET AL.

on human capital investment in the United States is that it is often unobservable and notoriously difficult to measure

(Blundell, Dearden, Meghir, & Sianesi, 1999). For example, corporate training as one form of human capital invest-

ment is often available only at the aggregated industry level.2In this paper, we circumventthis issue by focusing on

firms’ investment in workplace safety. Specifically, we utilize the establishment-level workplace injury data from the

Occupational Safety and Health Administration’s(OSHA) data initiative program (ODI).3Investing in workplace safety

represents an important form of human capital investment with direct implications for employee welfare and firms’

competitive position.4

Tocapture capital market frictions, we concentrateon the aspect of short selling, an important yet contentious issue.

Proponents argue that short selling allows for efficient price discovery and mitigates price bubbles,5while critics con-

tend that short selling plays a detrimental role to the capital marketby driving up stock market volatility and adversely

affecting stock prices.6Although this debate is ongoing and still largely unsettled, it is crucial to recognize that short-

selling activities reflect endogenous choices by traders. This identification challenge makes it empirically difficult to

isolate any causal effect of short selling on corporate behavior.

We get around this problem byexploiting a randomized experiment—Regulation SHO (Reg SHO). On July 28, 2004,

the Securities and Exchange Commission (SEC) introduced a new regulation removing short-sale restrictions from a

randomly selected group of U.S. stocks called pilot stocks. The pilot stocks consisted of every third one of the stocks

in the 2004 Russell 3000 index rankedby trading volume within each exchange. Pursuant to Rule 202T pilot program

(pilot programhereafter), these stocks were exempt from short-sale price tests between May 2, 2005 and July 6, 2007.

The relaxation of short-selling constraints increases short-selling pressure of the pilot firms. We posit that the

heightened short-selling pressure has a great impact on corporateinvestment decisions for two reasons. First, Diether,

Lee,and Werner (2009) confirm the significant role of short selling in the U.S. equity market by showing that short sales

amount to 24% and 31% of trading volume for the NYSE and NASDAQ,respectively. Second, as mentioned above, an

extensive literature provides evidence on the impact of short selling on price discoveryand informational efficiency

(e.g., Boehmer & Wu, 2013; Engelberg, Reed, & Ringgenberg, 2012), and informational efficiency in turn generates real

effects on corporate actions (Bond et al., 2012).

However,the impact of such increased short-selling pressure on investment in workplace safety is ambiguous. On

the one hand, a potential increase in short-selling pressure could lead managers to take a precautionary action by

increasing investments in workplace safety (managerial disciplinary hypothesis),as any adverse events such as worker

injury could potentially drawattention from short sellers whose trades will depress share value. On the other hand, the

removal of short-selling constraints could result in reduced investments in workplace safety.The rationale is that the

increasedrisk of stock price declines might induce managers to adopt a more myopic perspective by shifting their atten-

tion to more short-term activities and away from nonsalient, long-term investments,such as those in workplace safety

(performance pressure hypothesis). This is consistent with Graham, Harvey,and Rajgopal (2005), who show through a

survey of about 400 U.S. chief financial officers that 78% are willing to sacrifice long-term activities when faced with

short-term performance pressure.

2Somerecent studies examine human capital investments using non-U.S. firm-level trading data. For instance, Bapna, Langer,Mehra, Gopal, and Gupta (2009)

usefirm-level training data from an information technology outsourcing vendor located in India, and Konings and Vanormelingen(2015) use corporate training

datafor Belgian firms.

3Inthe aggregate, Leigh (2011) estimates that workplace injury and illness cost the economy approximately $250 billion for 2007.

4According to injury facts provided by the National Safety Council, work-related, medically consulted injuries amounted to $4.5 million in 2017, and total

workplace injury costs were estimated at $161.5 billion (https://injuryfacts.nsc.org/work/work-overview/work-safety-introduction/). OSHA also provides

evidenceon the economic benefits of firms’ investment in workplace safety. See https://www.osha.gov/dcsp/products/topics/businesscase/benefits.html.

5See Christophe, Ferri, and Angel (2004), Bris, Goetzmann, and Zhu (2007), Chang, Cheng, and Yu(2007), Boehmer, Jones, and Zhang (2008), Diether, Lee,

andWerner (2009), Karpoff and Lou (2010), and Boehmer and Wu (2013). See also the Financial Times article “Why Short Selling Is Good for Capital Markets”

(https://www.ft.com/content/cb22ac84-3cdb-11e0-bbff-00144feabdc0).

6See Brunnermeier and Pedersen (2005), Goldstein and Guembel (2008), and Shkilko, Van Ness, and Van Ness (2009). Also, a case in point is the

recent effort by China to restrict short selling in hopes of curtailing excess market volatility (https://www.wsj.com/articles/china-clamps-down-on-short-

selling-1438664957).