Dissecting the influence of geopolitical risks on employment decisions: The role of employment protection across countries

This study investigates the influence of geopolitical risk (GPR) on corporate labor investment choices. Anchored in real options theory, we demonstrate that GPR induces significant deviations from the optimal level of labor investment justified by economic fundamentals. Specifically, this greater labor investment inefficiency, characterized by higher abnormal net hiring, is primarily driven by under-investment in labor via over-firing. We identify rigidity in labor expenses and financial constraints as dual transmission channels, with the distortionary effects magnified among firms facing substantive adjustment frictions and financing constraints. We exploit cross-country variation in labor policies, establishing that stringent employment protection legislation (EPL) functions as an institutional counterweight: stringent EPL ex ante incentivizes firms to adopt precautionary employment strategies by avoiding an excessive workforce in anticipation of geopolitical instability. Finally, our additional analyses reveal that GPR significantly exacerbates employment–GDP growth procyclicality, whereas EPL functions as an institutional stabilizer that systematically counteracts this amplification. Collectively, our study delineates the disruptive influence of geopolitical tensions on employment decisions and highlights the institutional role of EPL in cushioning firms against inefficient labor investment and tempering the cyclical volatility of employment in an era of ongoing global turmoil.