Marco PaganoUniversity of Naples Federico II, CSEF,

EIEF and CEPR

FIRN Corporate Finance WorkshopSydney, 14 October 2013

Finance and labor:an overview

1

Expanding research field

Today I will focus only on three areas related to corporate finance:

1. Does corporate ownership (family vs. non-family) affect firm-level insurance provision to workers?

2. Does capital structure (leverage) affect the relative bargaining power of capital and labor?

3. What is workers’ role in corporate governance, and how does it affect firm performance?

But there are many other fast-developing areas: effect of finance on employment and job reallocation, effect of employment laws and trade unions on innovation and risk taking, etc.

2

Issue no. 1:

corporate ownership and

employment risk

3

Which firms are better at insuring employees?

In principle, large firms with good access to financial markets should be better at it

But if insurance is given via implicit long-term contracts, these firms also face greater commitment problems (“breach of trust”): managerial turnover hostile takeovers

Family firms can better commit to such contracts with employees: no danger of hostile takeovers family “name” is on the line: reputation!

Symmetric weakness: they often have no easy access to financial markets to unload risk

The verdict is up to the evidence…

4

French and U.S. evidence

In France, the pro seems to prevail on the con, at least for listed family firms in the late 1990s: heir-managed firms pay lower average wages and earn larger

profits, and their employment is less sensitive to industry sales shocks (Sraer and Thesmar, 2007)

family-promoted CEOs are associated with lower job turnover and less wage renegotiation (Bach and Serrano-Velarde, 2010)

family firms have fewer layoffs, sanctions and disputes ending in court (Müller and Philippon, 2007; Waxin, 2009)

In U.S. listed companies, the evidence is more limited: family management: downsizing is less likely, but more severe family owners: large job cuts (> 6%) are less likely (Block,

2008).

5

Worldwide evidence

Ellul, Pagano and Schivardi (2013) use data from 41 countries to investigate if employment and wages respond to sales shocks differently betweeno firms with different characteristics, e.g. family vs. non-

family

o in countries with different social arrangements, e.g. with high vs. low public provision of job security

Also look at interaction between the two: is the insurance role of family firms less prominent where there is more job security?

Distinguish between different types of shocks to sales: industry- vs. firm-level negative vs. positive transitory vs. persistent

6

Firm-level international data

Financial and accounting data from 41 countries for the period 1988-2011 obtained from Worldscope and Osiris

Use firms with employment data for at least 5 years: this screen reduces the number of firms to 6,298, i.e. 89,815 firm-year observations

Wage data is only available for 2,485 firms

Ownership data from Ellul, Pagano and Panunzi (2010) identifying a family as the firm’s ultimate blockholder

Dependent variable in the employment insurance regressions: log change of total employment

Two different dependent variables in the wage regressions : log change of real wage to test for wage insurance log of average wage to test whether insurance is priced

by wages

7

Country-level data

Country-level worker protection provided by social security system: gross replacement rates: unemployment benefits as

fraction of last wage, time-varying

Country-level worker protection provided by the market: labor market tightness: reciprocal of ratio of long-term

to total unemployed

Measure of financial development (stock market cap. to GDP)

8

Employment regression

The specification of the employment growth regression is:

ηijct = growth rate in the employment of firm i in year t εijct = measure of the shock: either the unexpected change in

the sales of firm i or the change in the sales industry j (ex-firm i) in year t

Fit = family-firm dummy – Family if a family blockholder has at least 20% of cash flow rights

Sct = replacement rate (measure of the effectiveness of the public employment insurance system) in country c and year t

Xijct = vector of company-specific variables μcj = country-industry effect μt = year effect

9

10

Employment insurance: industry shocks

(1) (2) (3) (4)Δ Industry Sales 0.1083**

(2.58)0.0906**

(2.27)0.0722**

(2.10)0.0863**

(2.39)Family Firms 0.0253

(1.27)0.0174(1.21)

0.0101(1.07) -

 Δ Industry Sales Family Firms

-0.0991***(-2.81)

-0.0898**(-2.49)

-0.0659**(-2.20)

-0.0750**(-2.40)

Δ Industry Sales Unemployment Security  

0.0314(1.46)

0.0415(1.44)

0.0259(1.24)

Δ Industry Sales Family Firms Unemployment Security  

0.1928**(2.10)

0.1399*(1.80)

0.1604*(1.88)

Δ Industry Sales Family Firms Labor Market Tightness

0.0049(1.28)

Control Variables Yes Yes Yes Yes

Fixed Effects Country-Industry

Country-Industry

Country-Industry

Firm

Year Dummies Yes Yes Yes YesR2 0.45 0.49 0.50 0.56

Insurance provided by family firms and social security

11

Vertical axis: country-level estimate of employment insurance provided by family firms

Wage growth regression

The specification of the wage growth regression is:

wijct = growth rate of the average real wage of firm i in year t εijct = measure of the shock (either to the sales of firm i or of

its industry j in year t) Fit = family-firm dummy variable (equal to 1 for family firms,

and 0 otherwise) Sct = replacement rate (measure of the effectiveness of the

public employment insurance system) in country c and year t Xijct = vector of company-specific variables μcj = country-industry effect μt = year effect

12

Wage insurance: industry shocks13

(1) (2) (3) (4)

Δ Industry Sales0.0426***

(3.12)0.0391***

(2.82)0.0340**

(2.53)0.0427**

(2.65)

Family Firms-0.0104*(-1.90)

-0.0095*(-1.70)

-0.0051(-1.52)

-

Δ Industry Sales Family Firms  0.0182**

(2.61)0.0109*(1.92)

0.0233**(2.35)

Δ Industry Sales Unemployment Security

-0.0186*(-1.70)

-0.0212(1.57)

Δ Industry Sales Family Firms Unemployment Security

0.0580*(1.74)

0.0662(1.50)

Firm Control Variables Yes Yes Yes Yes

Fixed Effects Country-Industry

Country-Industry

Country-Industry

Firm

Year Dummies Yes Yes Yes Yes

R2 0.10 0.12 0.12 0.12

Is employment insurance priced?14

(1) (2) (3) (4)

Family Firms -0.0921**(-2.45)

-0.0541**(-2.28)

-0.0380**(-2.04)

- 

Unemployment Security Family Firms

0.0047**(2.18)

0.0049**(2.05)

0.0041*(1.89)

0.0058**(2.28)

Financial Development Family Firms    

0.0030(0.92)

  

Unemployment Security0.0091(1.01)

0.0087(0.93)

0.0072(0.85)

0.0170(1.34)

Firm Control Variables No Yes Yes Yes

Fixed Effects Country-Industry

Country-Industry

Country-Industry

Firm

Year Dummies Yes Yes Yes Yes

R2 0.08 0.09 0.11 0.14

Is employment insurance priced? (2)

Firms that provide less employment insurance pay higher real wages

15

Horizontal axis: firm-level estimate of sales shocks “pass-through” (inversely related to employment insurance)

Vertical axis: firm-level wage net of industry, country and time effects

Issue no. 2:

capital structure and wage bargaining

16

Theoretical literature

By taking more debt, a company reduces “surplus on the bargaining table”: Baldwin (1983), Bronars and Deere (1991), Matsa (2010)

Perotti and Spier (1993) add incentive problem on shareholders’ side: debt not only reduces surplus, but also creates debt overhang shareholders have less incentive to invest wage concessions when profits are small

Dasgupta and Sengupta (1993) add incentive problem also on workers’ side: bankruptcy risk reduces workers’ effort (or investment in firm-specific human capital) too much debt not optimal

17

Evidence on debt and wages

Hanka (1998): U.S. firms with more debt pay lower wages and fund their pension plans less generously, controlling for performance

Benmelech, Bergman and Enriquez (2009): airlines in distress obtain wage concessions from workers with underfunded pension plans; effect is weaker for workers with greater pension insurance

Myers and Saretto (2010): in wage negotiations, unions are more likely to strike and “win” if firm debt has decreased in previous years; when firms win, they do not increase debt further

18

Evidence on debt and workers’ insurance

Hypothesis: when workers are protected by larger unemployment benefits, firm choose higher leverage

Agrawal and Matsa (2010) find precisely this using U.S. data from 1950 to 2008: increases in U.S. state unemployment insurance (UI) benefit entitlements are associated with increases in firm leverage. Doubling UI 4.1 percentage points increase in debt/assets ratio

Impact stronger for firms where workers face greater unemployment risk (layoff separation rates), that are more likely to fire workers in adversity (low operating cash flow, no dividend) and have greater labor intensity

19

Evidence on debt and unions

Matsa (2010): in the U.S., collective bargaining coverage and pro-union changes in state labor laws increase firm leverage (except in industries with low union presence). The same is found for Sweden by Cronqvist et al. (2009)

Bronars and Deere (1991): workers less likely to join a union if debt leaves less surplus on the bargaining table. In the U.S. leverage is higher in firms facing greater threat of unionization (but possible endogeneity bias)

Simintzi, Vig and Volpin (2009): in firm-level data from 21 countries, greater employment protection (EPL union power) leads to lower debt in countries with weak creditor rights (with likely renegotiation in bankruptcy)

20

International evidence on debt and EPL21

FR

US, CH, PT, GR

IE CA

SE

ES

JP

NL, DE, DK, AT, AU

NZ, UK

NO, IT, BEFI

-0.1

-0.08

-0.06

-0.04

-0.02

0

0.02

0.04

0.06

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5

Creditor Rights

Eff

ec

t o

f E

mp

loy

me

nt

Pro

tec

tio

n o

n C

orp

ora

te

De

bt

Source: estimates of Simintzi, Vig and Volpin (2009), Table VII, Column 3

Assessing existing evidence

U.S. evidence: in line with strategic view of corporate debt: leverage reduces wages, and is more intensively used when unions are stronger

International evidence: strategic use of leverage (more debt where unions are stronger) in countries with pro-liquidation bankruptcy law not in those with pro-renegotiation bankruptcy law

22

Workers’ protection in bankruptcy

Existing research neglects that there is much cross-country (and some time-series) variation in worker protection in bankruptcy: workers’ seniority in bankruptcy law government guarantees, in two varieties:

guarantee funds for wages, severance pay and pensions unemployment insurance benefit

Andrew Ellul and I have collected data on these items via questionnaires to Lex Mundi law firms (for OECD countries) information drawn from the web (for non-OECD countries)

We investigate how leverage correlates with workers’ protection: same spirit as Agrawal and Matsa (2010) for U.S.

23

Measuring worker seniority in bankruptcy

Worker seniority in liquidation differs across countries.Andrew Ellul and I looked at the rank of workers’ claims

relative to the following claim classes: secured debt (e.g. real estate mortgage loans) expenses of the bankruptcy procedure post-petition credit extended to debtor unpaid taxes unsecured debt

Define workers’ seniority from 0 to 4, so that 0 = they are treated as unsecured creditors, 4 = they are the most senior

24

Salary priority around the world

Salary priority

00.5

11.5

22.5

33.5

44.5

Aus

tria

Fin

land

Ger

man

yIr

elan

dS

lova

k re

publ

icA

ustr

alia

Den

mar

kLu

xem

bour

gN

ethe

rland

sN

ew Z

eala

ndS

wed

enS

witz

erla

ndT

urke

yU

SA

Bel

gium

Can

ada

Gre

ece

Hon

g K

ong

Icel

and

Italy

Japa

nK

orea

Mal

aysi

aS

inga

pore

Sou

th A

fric

aT

haila

nd UK

Spa

inA

rgen

tina

Nor

way

Pol

and

Bra

zil

Cze

ch R

epub

licF

ranc

eH

unga

ryIn

dia

Indo

nesi

aM

exic

o

25

Public guarantees around the world

Unpaid wages, retirement allowance and pensions are paid upfront by a government fund that acquires the same seniority as the workers, in all EU countries since the 1980s, based on Council Directive 80/987/EEC

(limits vary: e.g. 3 months’ pay in Germany, 5 in Hungary) Australia since 2001, with annual income cap of A$108,300 in 2010 Canada since July 2008, Hong Kong (both with caps) Japan: up 80% of unpaid wages and severance pay

In the U.S., pensions (only) are guaranteed by the PBGC, up to $51,750 per year/employee in 2008

No guarantee fund in: Argentina, Brazil, Malaysia, Mexico, New Zealand, South Africa

26

Unemployment benefits around the world 27

Average unemployment benefit replacement rates for 2 earnings levels, 3 family situations and 3 unemployment durations, sorted by 2007 level. Source: OECD.

0

10

20

30

40

50

60

Jap

an

Ca

na

da

UK

Gre

ece

US

A

Au

stra

lia

Ge

rma

ny

Ne

w Z

ea

lan

d

Au

stri

a

Ita

ly

Sw

ed

en

Sw

itze

rla

nd

No

rwa

y

Ne

the

rla

nd

s

Fin

lan

d

Sp

ain

Ire

lan

d

Fra

nce

Be

lgiu

m

Po

rtu

ga

l

De

nm

ark

1971

1981

1991

2001

2007

Merge these indicators with company data

We started exploring how firm-level leverage correlates with these measures of workers’ protection in bankruptcy

Our initial data set of company-level financial and accounting information: 11,290 firms from 38 countries, 1990-2008, drawn from Worldscope and Osiris

We only use firms for which we can find accounting data for at least 5 years: this reduces the number of firms to 7,588 94,056 firm-year observations

Standard errors clustered at the country-industry level

28

Leverage and workers’ protection in bankruptcy29

Dep. Variable: Book Leverage (1) (2) (3) (4) (5)

Salary Priority 0.0138***(2.98)

- - - -

Salary Priority x Firm Employees (Scaled by Assets)

- 0.0592**(2.09)

- - 0.0418*(1.89)

Unemployment Insurance - - 0.0218*(1.74)

- -

Unemployment Insurance x Firm Employees (Scaled by Assets)

- - - 0.0914(1.60)

0.0816(1.49)

Control Variables Yes Yes Yes Yes Yes

Firm Fixed Effects No Yes No Yes Yes

Industry and Time Fixed Effects Yes Yes Yes Yes Yes

No. of observations 94,056 94,056 94,056 94,056 94,056

Issue no. 3:

labor and corporate governance

30

Employees’ ownership and control rights

31 percent of U.S. workers invest in their company. Employee Stock Ownership Plans (ESOPs) have become common:

1,601 plans in 1974, 11,500 in 2000 5.3 million workers in 1980, 7.2 million in 1995

Co-determination is mandated by law in some countries: Germany: 1/2 of seats on supervisory board in companies

with more than 2,000 employees, 1/3 in listed companies with 500-2,000 employees

also in other EU countries workers have some control rights (see graph)

31

Mandatory control rights to workers32

0

1

2

Aus

tral

iaA

ustr

iaB

elgi

umC

anad

aC

zech

Rep

ublic

Den

mar

kF

inla

ndF

ranc

eG

erm

any

Gre

ece

Hun

gary

Irel

and

Italy

Japa

nK

orea

Mex

ico

Net

herla

nds

New

Zea

land

Nor

way

Pol

and

Por

tuga

lS

lova

k R

epub

licS

pain

Sw

eden

Sw

itzer

land

Tur

key

Uni

ted

Kin

gdom

Uni

ted

Sta

tes

Work councils mandated by law

Employees appoint some board members

Impact on corporate governance

Worker control rights may affect corporate governance, e.g. shift balance between shareholders and management

If there is separation between ownership and control, e.g. with dispersed share-ownership, it is a 3-players game:

33

shareholders

manager

workers

owner-manager agency conflict:manager steals or under-monitors workers

(if he owns a small equity stake)• industrial relations conflict over division of surplus • agency conflict: workers shirk, underinvest in firm-specific human capital • conflict if manager owns a large equity stake

• congruence if manager has small equity stake

Managers’ “easy life” and “natural alliance” with workers

Pagano and Volpin (2005): If managers have a small equity stake (conflict with

shareholders), they wish to overpay workers to buy an “easy life”: less monitoring, better industrial relations

They will also want to deter takeover raiders who would replace them

So their interest is aligned to that of workers: pay generous wages to buy an easy life deter control changes that would breach implicit contract

“natural alliance” between workers and managers in firms with owner-manager conflict (“bad governance”)

34

Evidence on “easy life” and “natural alliance”

Swedish managers go for the “easy life” (Cronqvist et al., 2009): wages are inversely associated with the manager’s equity stake (after

wage bargaining became decentralized)U.S. anti-takeover state laws in the 1980s were associated with

wage increases (Bertrand and Mullainathan, 1999)ESOPs correlate with

wage increases (Kim and Ouimet, 2009) less frequent takeovers (Chaplinsky and Niehaus, 1994; Beatty, 1995)

Successful raiders cut wages: transfer from workers to shareholders accounts for 10% of hostile

takeover premium in 18 subsequent years (Rosett, 1990) hostile takeovers lower union wage premium (Becker, 1995)

35

Incentive effects of workers’ ownership/control

So workers’ ownership and control tends to increase their “share of the pie”

But they may also change the “size of the pie” by affecting workers’ effort and human capital investment productivity workers’ cooperation in labor relations strike frequency corporate strategic choices company growth, profitability, ...

Most studies find that after ESOPs firms experience productivity increases (e.g. Jones and Kato, 1995; Beatty, 1995) positive stock price reactions (e.g., Chaplinsky and Niehaus,

1994)

36

Incentive effects (2)

Kim and Ouimet (2009) show that sign depends on stake: Tobin’s Q and profits increase for ESOPs < 5% are unaffected for ESOPs > 5%

Same for German codetermination (Fauver & Fuerst, 2006): it raises Tobin’s Q (in manufacturing and transportation) and

dividend payout, only if workers have at most 1/3 of seats

Greater cooperation in labor relations: ESOPs reduce strike incidence in labor disputes (Cramton,

Mehran and Tracy, 2008) in France, employee board representation reduces the

incidence of strikes and individual labor disputes (Waxin, 2009)

37

Conclusion

The interface between labor and corporate finance is capable of giving exciting insights, as it goes beyond the interplay between financial claimholders

Lively research area – yet, still much we don’t know

Part of the problem is practical: need to merge databases of worker-level or plant-level data with standard financial databases = lots of hard work!

Part of the problem is that “silo-busting is exceptional in academia – one is expected to specialize: there is a lot of turf warfare” (Jared Diamond, author of Guns, Germs and Steel, on yesterday’s FT, p. 13)

38