Academic journal article Indian Journal of Industrial Relations

Leverage & Trade Unionism in Indian Industry : An Empirical Note

Academic journal article Indian Journal of Industrial Relations

Leverage & Trade Unionism in Indian Industry : An Empirical Note

Article excerpt


The product market and input market effects of capital structure link the financial and real activities of a firm. A significant body of theoretical literature relates financial structure to market conduct and postulates strategic use of leverage by firms (Dasgupta & Sengupta 1993, Campello 2003, Cavanaugh & Garen 2004). Notwithstanding the advancements in the theoretical literature, empirical evidence on this aspect is far less convincing. The present note addresses this gap in the literature by demonstrating that strategic incentives from input markets have an impact on financing decisions.

Existing evidence on the link between collective bargaining and capital structure determination relies on cross-sectional comparisons that may be affected by omitted variable bias. Bronars and Deere (1991), for instance, show that unionization rates are correlated with financial leverage at the industry level. This sort of analysis, however, fails to take cognizance of the strategic increases in debt from the more 'mechanical' balance sheet effects.

We identify the strategic effect empirically using profitability across industries which reflects differences in the specific product markets in which industries compete. When labour and management bargain, a union can claim a portion of the firm's excess liquidity--its operating cash flow- net of any required debt payments. Collective bargaining, therefore, imposes a greater threat to a firm when a firm maintains higher levels of excess liquidity. With limited liability and positive debt balance, greater underlying profit is one factor that increases expected excess liquidity and a firm's susceptibility to union rent seeking. Greater profitability of potential projects implies that the firm must, on average, maintain greater excess liquidity in order to fund the same marginal project. Profitable firms are thus more vulnerable to union rent seeking and therefore, have greater incentive to use debt to shield liquidity from workers in bargaining. Consequently, evidence of the strategic effect can be found by analyzing the interaction between union bargaining power and firm profitability.

The remainder of the paper proceeds as follows. The empirical model is presented in the subsequent section, along with the data base employed for the purpose. This is followed by a discussion of the results. The final section concludes.

Empirical Strategy

The degree of union bargaining power in negotiations with a given industry is likely to increase with the proportion of employees covered by the bargaining process. In industries with greater coverage, union-organized job actions are likely to be more costly, and as a result, industry-wide policies are more likely to be affected by bargaining. We use industry-level data on bargaining as a proxy for union bargaining power and estimate its effect on the firm's choice of capital structure.

The empirical equation for industry j at time t can be specified as follows :

[Debt.sub.j,t] = [[eta].sub.j] + [a.sub.2] * Coverage + [a.sub.3] * Profit + [a.sub.4] (Coverage * Profit) + [beta] * {Control variables)+ [z.sub.j,t] (1)

where (ignoring subscripts) Debt is the debt profile of the industry which is modeled as a function of the proportion of employees covered by bargaining (Coverage), industry profits (Profit) and the interaction of Coverage and Profit, a set of control variables [Controls] and two-digit NIC industry fixed effects, [eta]. Finally, z denotes the error term.

As regards the dependent variable, we employ both the level of debt as well as its composition. Accordingly, we estimate alternate specifications where the dependent variable is defined in terms of both the level of debt (such as total debt and total bank debt) as well as its composition (defined in terms of the debt equity ratio and the proportion of bank debt to total debt). (1)

Among the independent variables, following from the literature (Bhattacharjee & Datta Chaudhuri 1994), Coverage is measured as the number of employees registered as trade union members divided by total number of employees. …

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