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Corporate Governance, Non-Financial Stakeholders, and Innovation: Evidence from a Natural Experiment

I examine whether greater protection of non-financial stakeholders such as employees, customers and the community can enhance corporate benefits to these stakeholders, and hence impact firm innovation, value and capital structure. Using the exogenous passage of Constituency laws to measure stakeholder protection, I find that firms incorporated in states that pass the laws have a higher number of stakeholder-friendly policies. More importantly, I demonstrate that after the increase in stakeholder protection, firms with weaker governance experience lower innovation and firm value, and higher leverage than firms with better governance. This paper illuminates an understudied aspect of corporate governance by showing that managers are influenced by the diverse interests of financial and non-financial stakeholders, when determining investment and financial policies.