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«Working Paper = = Unionization, Cash, and Leverage Martin C. Schmalz Stephen M. Ross School of Business University of Michigan Ross School of ...»

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Working Paper

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Unionization, Cash, and Leverage

Martin C. Schmalz

Stephen M. Ross School of Business

University of Michigan

Ross School of Business Working Paper

Working Paper No. 1215

April 2015

This work cannot be used without the author's permission.

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rkfsbopfqv=lc=jf`efd^k= Unionization, Cash, and Leverage Martin C. Schmalz∗ Abstract What is the effect of unionization on corporate financial policies? The average unionized firm responds with lower cash and higher leverage to a unionization election than the average firm escaping unionization. However, using a regression discontinuity design I find that the causal effect of unionization is close to zero on average, but heterogeneous across firms. For the subset of large and financially unconstrained firms, the causal effect is positive on leverage and negative on cash; the opposite is true for small and financially constrained firms. These results help reconcile controversially discussed views on how corporate finance and labor interact.

JEL Classification: J50, G32 Keywords: Unionization, cash, leverage, capital structure, labor adjustment costs ∗ schmalz@umich.edu. Stephen M. Ross School of Business, University of Michigan. This paper is based on the first chapter of my dissertation at Princeton University. I am deeply grateful to my adviser Markus Brunnermeier, as well as to David Sraer, Alexandre Mas, and David Lee for invaluable support, ideas, and advice, and to David Lee and Alexandre Mas for generously providing data. For helpful discussions and comments, I would like to thank Sergey Zhuk and other Princeton classmates, John DiNardo, Henry Farber, Mireia Giné, Bo Honoré, Oleg Itskhoki, Martin Kanz, Hyunseob Kim, David Lee, Thomas Mertens, Roni Michaely, Benjamin Moll, Ulrich Müller, José Scheinkman, Matthew Serfling, Hyun Song Shin, Toni Whited, as well as seminar participants at Bocconi, Boston University, Columbia GSB, Harvard Business School, HSE Moscow, IESE, INSEAD, London School of Economics, University of Michigan (Finance; Labor Economics), NBIM, Ohio State University, Princeton, Rochester, SMU, UC Irvine, University of Vienna, USC, and USI Lugano. Laurien Gilbert and Alexis Furuichi provided excellent research assistance. I gratefully acknowledge generous financial support through a Fellowship of Woodrow Wilson Scholars and an NTT Fellowship from the Mitsui Life Financial Center.

1 Introduction Two polar views shape the debate on the interaction between labor and corporate finance.

According to one view, firms strategically choose their financial policies to attain a better bargaining position in future wage negotiations with their employees. In particular, according to this “bargaining view,” firms respond with higher leverage and lower cash to unionization or the threat thereof [Bronars and Deere, 1991, Matsa, 2010]; see also Baldwin [1983], Dasgupta and Sengupta [1993], Perotti and Spier [1993], Sarig [1998]. The intuition is simple: unionized workers have a decreased ability to extract rents when the firm has low cash reserves and already committed future cash flows to debt holders. Therefore, reducing financial flexibility can reduce workers’ incentive to unionize.

The alternative view holds that an increase in fundamental or operating risk arising from more rigid labor inputs leads to an increased need for financial flexibility [Mauer and Triantis, 1994, Gamba and Triantis, 2008, Pratt, 2011, Kahl et al., 2013, Chen et al., 2013].1 Unionization is one reason why an increase in labor rigidity can occur. Therefore, according to the “financial flexibility” view, unionization should cause an accommodating response with more cash and less leverage.

While often discussed controversially, there is no contradiction between these forces. In theory, both can be present at the same time in the same firm, whereas it is an empirical question which one is quantitatively more important in the average firm, or in particular subsets of firms. Also, it is conceivable that the “bargaining” motive is more important ex ante (before a unionization attempt), whereas the “financial flexibility” motive is more important ex post (in case actual unionization occurred).2 Lastly, it is important to understand if the response of firms becoming unionized is the This prediction is also consistent also with models emphasizing the effect of asset-market frictions on liquidity risk management [Bolton et al., 2011]. Note that human capital is an asset without market liquidity from the perspective of the firm. A similar prediction arises from firms’ internalization of expected costs of bankruptcy born by their employees [Titman, 1984, Jaggia and Thakor, 1994, Berk et al., 2010]: implicit promises of wage insurance are only credible when the firm has the financial reserves to honor them. Agrawal and Matsa [2012], Brown and Matsa [2012], Kim [2012], Chemmanur et al. [2013] provide empirical support for variations of the insurance hypothesis, see also Caggese and Cuñat [2008], Sraer and Thesmar [2007], Shivdasani and Stefanescu [2010], Ellul et al. [2013].





The effect could also be non-monotonic: too much financial flexility can hurt a firm’s bargaining position, whereas too little financial flexility can reduce shareholder value because of financial distress costs. The empirical question is what the marginal effect of unionization is on the optimal level of financial flexibility.

effect of unionization per se (i.e., the effect of changes in labor rigidity as well as how bargaining is conducted as a result of unionization), or if the response is driven by potentially unobservable variables that are correlated with more or less strong support for unionization, such as employee morale. In other words, what is the causal effect of unionization on corporate financial policies?

As is evident from an active empirical literature on the effect of unionization (and labor rigidity more generally) on corporate financial choices, there is much interest in these questions. Indeed, approaching answers to them is of first-order importance for advancing our understanding of which theories are most important in describing corporate financial decision making.

To answer these questions, this paper employs a data set that contains all unionization elections in U.S. establishments belonging to Compustat firms between 1961 and 1999. The data set and research design I use was first developed by DiNardo and Lee [2004], and extended by Lee and Mas [2012] to study the causal effect of unionization on productivity and wages as well as on stock returns, respectively. In contrast to earlier papers in the corporate finance literature that have used variation in the ability to form unions at the state or industry levels, I directly examine firms experiencing a unionization attempt. The research design also allows me to determine the causal effect of unionization on firm policies.3 I find that the average firm experiencing a unionization election reduces its cash-to-asset ratio and increases leverage. This observation is consistent with the bargaining view, but also with the notion that firms in bad financial condition impose more unemployment risk on employees, and employees facing higher unemployment risk have higher incentives to (attempt to) unionize in order to enjoy better protection of their interests in bankruptcy. Next, firms in which more than 50% of workers voted for unionization (which almost surely leads to unionization of the establishment) respond with 2% lower cash-to-asset ratios and +0.8% higher leverage to an election, compared to firms in which less than 50% voted for unionization (which almost never leads to unionization). This The data go back much further in time than other papers using the election design to investigate the unionization effect on other outcome variables, such as innovation [Bradley et al., 2013] or staffing levels and quality [Sojourner et al., 2012].

result is consistent with the predictions of the bargaining view. Importantly, however, this analysis ignores the information content of the precise share of the vote cast in favor of unionization, i.e., it gives equal weight to unionization events in which 100% of workers voted for unionization and events in which only 50.1% voted for unionization.

Because the degree of union support, reflected in the vote share for unionization, may be correlated with unobserved characteristics of the firm or the workforce, estimating the causal effect of unionization requires comparing observations in which only unionization but none of the other characteristics changed significantly. The discontinuity in unionization outcomes at the 50% vote share threshold affords such a comparison. I find that the financial policy response of close “winners” (from the perspective of the union) and close “losers” is almost identical, both in terms of cash and in terms of leverage. Thus, the causal effect of unionization per se is zero; the average effect is entirely driven by the tails of the vote share distribution. From this result alone, one can either conclude that the “bargaining” and “flexibility” effects exactly cancel out for the subset of firms at the discontinuity, or that unionization per se is not a first-order driver of corporate financial policy.

To try and tell apart these interpretations, I analyze the average and causal effects of unionization in subsamples of the data. If there is truly no causal effect of unionization, that should be true in subsamples of the data as well. By contrast, if both mechanisms are equally important for the average marginal firm, perhaps one is more important than the other in subsets of firms. To investigate this possibility, I split the sample by the degree to which the firms can freely adjust their financial policy at the time of the unionization election, as measured by ranking below (unconstrained) or above (constrained) the median of the Whited and Wu [2006] index of financial constraints. A firm presently unconstrained can become constrained in the future, and therefore has a motive for risk management; according to the flexibility view, it should increase cash and decrease leverage in response to an increase of labor rigidity. By contrast, a firm presently constrained faces a tradeoff between two exclusive uses of the existing levels of cash and debt capacity: using (and thus reducing) it now for investment, or keeping it for the future [Rampini et al., 2014]. Thus, a presently constrained firm will, if anything, reduce its financial flexibility in response to an increase of labor rigidity, but definitely not increase it (because it can’t). By contrast to these predictions, the simplest version of the bargaining view prescribes a tightening of financial flexibility for both types of firms.

Using the regression discontinuity design, I find that unionization causes a 6.2% increase of cash-to-assets ratios among financially unconstrained firms. This effect, corresponding to a 0.43percentage-point increase from 6.86% to 7.29%, or $23 million for the average firm, is not only highly statistically significant but also economically sizable: the increase corresponds to about 13% of the average firm’s wage bill. I also find a highly statistically significant 2.4% reduction of on-balancesheet financial leverage, which corresponds to a 1-percentage-point decrease of leverage from 42.8% to 41.8%, or a $63 million reduction in debt financing. By contrast, financially constrained firms reduce cash and increase leverage, although these estimates are less precise. I view these results as most easily compatible with the view that financial flexibility is a relatively more important consideration for firms that can actively and freely adjust their financial policies. (Indeed, financial flexibility is considered the most important driver of corporate financial decisions in general [Graham and Harvey, 2001].) This interpretation is also corroborated by the finding that the average effect of unionization reported above (a decrease of cash and increase in leverage) is entirely driven by the subsample of financially constrained firms, which presumably cannot freely adjust their financial policies.

An alternative interpretation is that bargaining considerations are relatively more important in firms that are already financially constrained, whereas they are less important compared to financial flexibility in less financially constrained firms. Given the finding by Benmelech et al. [2012] of a link between financial distress and wage concessions, this interpretation seems plausible; however, a different explanation would need to address why bargaining considerations are unimportant in financially unconstrained firms.4 Under either interpretation, the RD results indicate that unionGiven that the measure of financial constraints I use is highly negatively correlated with firm size, the interpretation could also be that the bargaining motive is more important for small firms and financial flexibility is a more important concern for larger firms, e.g. because an increased cost in quasi-fixed [Oi, 1962] labor costs has the potential to spill over to other plans. Also, there is an ongoing debate on how well measures of financial constraints ization per se is indeed an important determinant of corporate financial policies, but the effect is heterogeneous across firms.



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