The Threat of Unionization, the Use of Debt, and the Preservation of Shareholder Wealth
Bronars, Stephen G., Deere, Donald R., Quarterly Journal of Business and Economics
Under U. S. labor law firms cannot prohibit their employees from attempting to form a collective bargaining unit. Firms can, however, take actions to reduce the impact of collective bargaining on profits. Given the apparently large effects of unions on shareholders' wealth presented by Ruback and Zimmerman |1984~ and others |Clark, 1984; Salinger, 1984; Voos and Mishel, 1986; Bronars and Deere, 1990~, we expect firms to protect shareholders' wealth from union appropriation.
One method of lessening the impact of unionization on shareholders is to reduce the probability of its occurrence. The firm can accomplish this by paying higher wages. In effect, the higher wage serves as a type of limit price. Because workers must bear the cost of union formation, firms can pay a limit wage that is strictly less than the union wage. Thus, although labor costs are increased by this strategy, profits are higher than if a union were to form. The firm can also alter its mix of employees to make it more difficult for a coalition favoring unionization to arise.(1)
This paper analyzes an alternative response to unionization: firms can use debt policy to limit the effect that a successful union has on shareholder wealth. A union can extract no more than the present value of future net cash flows at the time of unionization. By issuing debt instead of equity, firms are obligated to repay a portion of future revenues to creditors. Hence, these obligations limit the revenues that a union can extract without driving the firm into bankruptcy.(2)
Consider these two potential responses to the threat of unionization. Firms can pay a greater portion of cash flows to workers in an effort to stave off unionization, or firms can reduce the losses in the event of unionization by using debt to divert future cash flows to shareholders. Shareholders prefer the latter response because it shifts cash flows to them rather than to current (nonunion) workers. The paper carefully models the firm's debt choice in a union environment and then empirically analyzes the relationship between unionization and debt.
The key empirical implication of the model is that a firm facing a greater threat of unionization chooses a higher debt-equity ratio. Given that firms in heavily unionized industries have experienced greater union threats on average, we test this hypothesis by comparing industry unionization rates and industry average debt equity ratios. We find strong evidence of a positive relationship between unionization and debt-equity ratios using a set of large, publicly traded firms.
The next section analyzes how debt can be useful in limiting the effect that unionization has on the wealth of shareholders. The broad issues are discussed, and then two separate models of the union-firm negotiating process are used to derive implications for the relationship between the threat of collective bargaining and a firm's debt policy. Section III develops the empirical model, describes the estimation procedure, and presents the estimation results.
II. THEORETICAL CONSIDERATIONS
In order for shareholders to decide how to limit the impact of unionization, they must have some knowledge of the union-firm bargaining process. There is no consensus on modeling the bargaining between unions and firms. Traditional wage-setting models are criticized for their inefficiencies; rent-maximizing models may not be realistic; and more general Pareto optimal bargains that allow for union objectives that trade off employment and wages are unsatisfying because of their sensitivity to the specification of these objectives. Recent empirical work on this issue (see, e.g., MaCurdy and Pencavel |1986~, Brown and Ashenfelter |1986~, Eberts and Stone |1986~, Card |1986~, and Abowd |1989a~) is decidedly mixed. Given the lack of empirical support for any particular model, it is important not to rely on a single bargaining solution.
We begin by describing the basic setting in which the shareholders and the union reach an agreement. …