Having a Finger in the Pie: Labor Power and Corporate Payout Policy

By Haw, In-Mu; Hu, Bingbing et al. | Financial Management, Winter 2018 | Go to article overview

Having a Finger in the Pie: Labor Power and Corporate Payout Policy


Haw, In-Mu, Hu, Bingbing, Wu, Donghui, Zhang, Xu, Financial Management


Extant literature indicates that corporate payout policy is profoundly influenced by the legal protection of shareholders and creditors (La Porta et al. 2000; Brockman and Unlu, 2009). However, another important stakeholder, labor, has received less attention in this line of research. As a claimant to firms' economic resources (Clark, 1984; Ruback and Zimmerman, 1984; Rose, 1987), labor naturally prefers greater retention of profits over cash distribution and, as such, has the potential to influence rent distribution among stakeholders. In this study, we investigate whether and how the legal power of labor influences firms' payout policies.

Given that labor is able to bargain for a share of firms' profits, strong labor power imposes an implicit constraint on the rent distribution to shareholders (the bargaining view). Recognizing labor's rent extraction, managers may strategically make large payouts to shield corporate cash from labor's capture (the strategic payout view). The two competing views generate opposite theoretical predictions about the impact of labor power on corporate payouts. Using a large sample of 364,218 firm-years from 39 countries from 1989 to 2015, we investigate how shifts in labor power triggered by changes in country-level labor laws affect corporate payouts. We exploit exogenous changes in labor laws across countries to conduct a difference-in-differences (DID) analysis. Our focus on country-level labor power complements prior studies that investigate the effect of country-wide shareholder and creditor protection on corporate payout policy.

Since a time dimension is critical for establishing the causal relation between labor power and payouts, we employ a longitudinal Labor Regulation Index of the Centre for Business Research (hereafter CBR-LRI) constructed by Adams, Bishop, and Deakin (2017) that covers a wide range of countries over a long period of time. They code country-level labor laws in five areas: 1) regulations of alternative employment contracts, 2) regulations of working time, 3) rules on dismissal, 4) regulations of employee representation, and 5) rules governing industrial action, producing five subindices. Regulations in the first three areas deal with individual employment relations (employment protection laws), while the latter two apply to the collective relations by regulating the bargaining, adoption, and enforcement of collective agreements, the organization of unions, and industrial action (collective relations laws). Thus, laws in the latter two areas determine the extent of collective bargaining power and capture labor's ability to influence firms' decision making. Since we are interested in how labor power collectively influences corporate payout policy, we construct an average value of the latter two subindices as a time-varying measure of labor power.

Our DID design, exploiting the intertemporal variations in labor legislation, identifies the effect of labor power on firm payouts by comparing changes in payouts for firms that are subject to a change in labor regulations (treated firms) with changes in payouts for firms that are not exposed to a law change (control firms). Our empirical specifications control for time-invariant firm characteristics through firm fixed effects, industry-level time-varying factors through industry/year fixed effects, country-specific time trends, and a set of time-varying firm- and country-level control variables. We find that firms undergoing a change in labor legislation that strengthens labor power reduce their dividend payments and total payouts relative to a set of control firms operating in the same industry and year, but located in countries without a change in labor legislation. In terms of economic significance, a one-standard-deviation increase in the labor power index leads to a 0.374 percentage point decrease in the total payouts-to-sales ratio or a 0.443 percentage point decrease in the dividends-to-sales ratio, representing a 22. …

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