We study the firm-level and aggregate effects of government-imposed employment targets. We develop a dynamic general equilibrium model with heterogeneous firms and endogenous productivity growth in which penalties for below-target hiring generate a polarization mechanism: low-productivity firms exit, while others expand employment beyond efficient levels, and firms invest in productivity to avoid future penalties. We test and confirm the model’s firm level predictions using unique contractual data on more than 18,000 employment commitments from the East German privatization, exploiting quasi-random variation in the assignment of privatizers to firms. Quantitatively, employment targets reduce unemployment and raise welfare in the short run, but these effects fade as distorted labor allocations and weakened investment incentives slow aggregate productivity growth, leaving no lasting welfare gains. We also evaluate how alternative designs for employment-protection (e.g., the choice between mandates and subsidies, the structure of targets) impact misallocation and the resulting short- and long-run outcomes.

Does debt overhang distort only investment? This paper analyzes the subsequent effects of debt overhang on firm-level outcomes. Using an event study for German firms from 2004 to 2021, we find that, relative to comparable firms in the same industry and year, highly indebted firms do not merely invest less, which is the classic overhang result. They also hire less, and the two margins together translate into slower sales growth. The composition of the adjustment, however, depends on the firm’s growth regime. Highly indebted firms that keep expanding slow their hiring but raise capital per worker over the long run, substituting capital for labour along a flatter expansion path. Highly indebted firms that contract shed workers with no offsetting change in capital intensity: they scale down rather than restructure. These patterns hold in normal times as well as in crises and are concentrated among small and medium-sized limited-liability firms. Debt overhang is therefore not a pure investment wedge but a persistent drag on firm scale, whose incidence across inputs is determined by whether the firm is growing or shrinking.