Union Decertifications's Impact on Shareholder Wealth

Union Decertification's Impact on Shareholder Wealth

THOMAS G. PEARCE, JAMES E. GROFF, and JOHN R. WINGENDER"

Recent research correlated share price declines in financial markets with union organizing. Investors seemingly anticipate a redistribution of earn- ings away from shareholder returns toward employee compensation. The markets discount security prices accordingly. But were that the case, union decertification activity should correlate with persistent, abnormally high returns on equity investments. Failure to find returns that are both abnormally high and persistent invites an alternative explanation that is consistent with the data from both studies. This study finds that firms that retained union representation in decertification cases actually outper- formed those that ousted the bargaining agent in a partitioned sample comparison.

THE ECONOMIC IMPACT of labor relations events on firms has attracted increased research attention recently (Becker, 1987; Becker and Olson, 1986; Hirsch and Connolly, 1987). Changes in aggregate shareholder wealth, as derived from changes in publicly traded securities in equity markets, offer one way to measure the impact of such episodes. Researchers have applied this approach to various labor relations events: strikes (Neu- mann, 1980; Greer, Martin, and Reusser, 1980; Becker and Olson, 1986), contract negotiations (Abowd, 1985, 1989), two-tiered wage agreements (Thomas and Kleiner, 1992), boycotts (Pruitt, Wei, and White, 1988), profit

*The authors' affiliations are, respectively, Department of Business Administration, Moorhead State University; Department of Accounting and Information Systems, University of Texas at San Antonio; and Department of Finance, Oklahoma State University. The authors gratefully acknowl- edge the support of the Office of Business and Economic Research at Oklahoma State University for this study.

INDUSTRIAL RELATIONS, Vol. 34, No. 1 (January 1995). 0 1995 Regents of the University of California Published by Blackwell Publishers, 238 Main Street, Cambridge, MA 02142, USA, and 108 Cowley

Road, Oxford, OX4 lJF, UK.

58

Union Decert8cation’s Impact on Shareholder Wealth I 59

sharing in unionized firms (Florkowski and Shastri, 1992), union organizing (Ruback and Zimmerman, 1984; Abowd, Milkovich, and Hannon, 1990; Bronars and Deere, 1990), and union decertification influences on equity markets (Huth and MacDonald, 1990). The work concerning union representation events provides the impetus for this study.

In 1984, Ruback and Zimmerman employed an event study methodology to test the effects of union organizing activity on changes in shareholder wealth. When organizing efforts succeeded, they found that share prices fell 3.8 percent after controlling for general market movements. They observed a 1.3 percent decline in equity values even when unions lost such certification elections. The authors concluded that the appearance of union organizing activity augurs ill for the investor, suggesting the prospect of diverting more of the firm’s profit stream away from shareholders and into workers’ compensation packages. Empirical work by Abowd (1985), Clark (1984), Connolly, Hirsch, and Hirschey (1986), and Voos and Mishel (1986) supports this conclusion by finding negative impacts from unionization on firm profitability. If unionization leads to a decrease in future cash flows to shareholders, then we hypothesize that decertification should lead to increased cash flows to shareholders in the form of positive equity share price movements.

While the increased labor cost explanation may be intuitively appealing, at least one alternative interpretation of the data is plausible. Unionization causes structural changes in the operating procedures of the firm. Produc- tion processes tend to become more standardized in the face of negotiated agreements. At a minimum, the change from a union-free work force to a unionized one requires changes in the way management exercises its supervision, handles worker grievances, hires and terminates employees, as- signs overtime, subcontracts certain tasks and processes, and negotiates wages and benefits. Whether the same management team and managerial philosophy will prove equally effective in a new operating environment may be open to question. Financial markets equate uncertainty with risk. Share price declines may come about as a result of higher operating costs and a resulting decrease in profit margin, as Ruback and Zimmerman suggest. But such share price declines may also come about as investors perceive increased uncertainty about the ability of the firm’s management to remain equally effective under different constraints and accommoda- tions. While management may have the choice to introduce changes in modes of supervision and operations following a union decertification, it does not follow that the exercise of such options is smooth or unfettered by practical considerations. Workers may harbor strong and potentially linger- ing sentiments that constrain management’s ability to define and imple-

60 / THOMAS G. PEARCE, JAMES E. GROFF, AND JOHN R. WINGENDER

ment new modes of supervision and operations. Even if the changes management identified and sought to introduce were precisely the sort on which investors would look with favor, it might not be possible to effect such changes quickly or without encountering resistance on the shop floor. The myriad of changes faced by management with respect to a newly unionized work force may have been studied extensively, but the patterns and practices of the management team in a newly decertified work environment are considerably less well documented. Without the standardized processes and procedures codified in a negotiated agreement, inconsisten- cies and inefficiencies may well arise in operations involving newly decertified labor groups. Projections of firm performance under such con- ditions are clearly fraught with uncertainty, and we would expect financial markets to capture such uncertainty as part of the risk associated with the firm’s financial securities. Thus, share price changes may arise in response to investor expectations of changes in economic returns, in response to uncertainties associated with a different labor-management environment than was previously present, or in response to some combination of both.

These competing explanations are difficult to analyze in the context of certification activity because they would each affect share prices in the same downward direction. With decertification events, however, the effects of higher union wages and the effects of increased investor uncertainty operate in opposite directions. The magnitude of change going from a union-free environment to a unionized one is analogous to the magnitude of change in the opposite direction for any given firm. However, the compensation effects would differ. Investors may reasonably expect newly unionized firms to divert profits from shareholders to wages and benefits for workers under the Ruback and Zimmerman analysis. But following decertification of the bargaining agent, compensation package increases would presumably be slower to increase than would otherwise be the case. We would expect positive effects on anticipated shareholder returns.

A study by Freeman and Kleiner (1986) offers support for an alternative interpretation. They compared recently unionized firms with others that had remained unorganized throughout the period of their study. They matched firms with respect to geographical area, size, and industry. They reported that newly organized work forces did not quickly secure the wage premiums that are generally associated with unionized firms. In fact, the compensation packages during the early years of a bargaining relationship did not differ significantly from the compensation packages in the nonunion firms with which Kleiner and Freeman paired them. However, the propor- tion of firms that adopted a formal grievance system in the newly organized group increased by almost half, whereas only modest increases in the intro-

Union Decertification’s Impact on Shareholder Wealth I 61

duction of such systems appeared in the control group. Contractual senior- ity rights in the face of layoffs and the posting of job openings for internal bidding also increased much more in the recently organized firms than in their nonunion counterparts. To adopt Hirschman’s terminology,l these “voice” effects would seem to be immediate, while the economic consequences of unionization phase in more gradually. Knowledgeable investors should, therefore, discount these remote economic prospects more heavily. It is the nearer-term voice effects that we would expect to foster the changes in personnel practices and other operating routines in the firm.

This study attempts to weigh these competing explanations.

Data The decertification of a union bargaining agent has been a feature of

U.S. labor law since the adoption of the Taft-Hartley Act in 1947.2 While the process of decertification generally mirrors the certification procedure, important differences exist in practice (Pearce and Peterson, 1987). In the present study, we concern ourselves only with cases that culminate in NLRB-supervised representation elections.

From the NLRB Monthly Election Reports series for the period January 1963 through December 1986, we identified all decertification elections for which daily stock price data were available to us. We used the Center for Research on Security Prices (CRSP) daily stock return data base. We included only those firms whose shares were publicly traded on the New York Stock Exchange (NYSE) at the time of the decertification events. In an attempt to assure that the decertification activity had a material effect on the firm, we eliminated from our sample those cases in which the bargaining unit had fewer than 100 employee^.^ These criteria provided an initial sample of 277 cases.

For each of these cases we filed a Freedom of Information Act request with the NLRB regional office involved. We asked the NLRB offices to provide the filing date of the decertification petition, the date the bargaining unit election was held, and the date the results were formally an- nounced. All thirty-five regional offices we contacted responded to our requests. These data enabled us to translate the events that we initially identified on the basis of the board’s Monthfy Election Reports into a form

See A. 0. Hirschman (1970).

Ruback and Zimmerman (1984) and Bronars and Deere (1990), who employed the same data base, used only bargaining units of 750 or more employees. Since we included smaller bargaining units in our sample, any bias in our results should be toward failure to find significant stock price responses.

2 See Section 9(c)(l)(A)(ii) of the National Labor Relations Act, as amended.


that we could use in conjunction with the daily series on the CRSP tapes. After we obtained the dates associated with the decertification activities, we imposed three additional constraints. First, we eliminated any case in which any one of the three dates (the date of the petition filing, the date of the actual election, and the date of the board’s announcement of the election results) was missing. Then to perform the capital markets tests, we required a complete stock price series for 30 days around each event date and 135 days prior to the petition filing date. Finally, we identified firms in our sample that had newsworthy events other than the labor event in question that could have contaminated the data. Merger and major acquisition or divestiture announcements, the death of a prominent corporate officer, and other important events triggered the removal of the case from our sample. The final sample contained a total of 153 cases.

Although we developed this final sample along similar lines employed by Huth and MacDonald (1990), there were several differences. Our approach led us to a final sample of different size as well as to different conclusions, so it is important to delineate these distictions. While we began with the NLRB Monthly Election Reports as did Huth and Mac- Donald, we handled the data somewhat differently. We used the 1986 daily CRSP tape, which included only NYSE firms. The Huth-MacDonald study included cases in early 1987, by which time both NYSE and American Stock Exchange firms were included on the CRSP tape. Over the course of the period we considered, the inclusion of American Stock Exchange firms as well as those listed on the New York Stock Exchange probably accounts for some of the difference in size between the data sets in the two studies. While we included cases over a longer period of time and that would seem likely to increase the number of cases in the data set, decertification activity levels were considerably lower during the earliest part of the interval covered in our analysis. Over the course of the twenty-four-year period of our data, this difference could also explain a portion of the difference in total cases in the respective data sets. Besides including cases over a longer period of time, we also included smaller bargaining units (> 100 members vs. >250 members for the Huth-MacDonald study). This would also have presumptively increased the size of our sample.

Other differences may have operated to reduce the number of cases in our study, relative to one employed by Huth and MacDonald. Huth and MacDonald eliminated companies for which data were lacking for the events of principal focus. We did so as well, but in addition dropped cases for which there were missing data during the estimation period, too. Where Huth and MacDonald identified two events of concern (petition filing date and election results announcement date), we included a third event date

Union DecertiJcation’s Impact on Shareholder Wealth / 63

(the actual date of the bargaining unit election). This third event created the possibility of missing data on days which would have caused a case to be dropped from our analysis but not from the Huth-MacDonald study. Of the three event days of concern to us, the actual election date proved to be the one for which data were most often missing.

Perhaps the most important difference in the way we trimmed our sample concerned the estimation period and the event window. Huth and MacDonald employed a total event horizon of 260 days, a 239-day estimation period and a 21-day event window. We employed a 135-day estimation period and a 31-day event window. Of the two intervals, the duration of the event window per se is the more important methodological difference. A longer event window facilitates better consideration of the persistence of an initial reaction to the event in question.

Finally, we also dropped cases when news items about the firm appeared in the business press that seemed to be unrelated to the labor events upon which we had chosen to focus. Examples of such items include announcements of stock splits, the sudden demise of a major corporate officer, change in dividend policy, or the prospect of a significant merger and/or acquisition. Huth and MacDonald did not report any similar screening of the cases they included in their final sample.

As a rough comparison of the effects of screens employed, our approach dictated that we drop 45 percent of the cases in the initial data set, whereas the approach followed by Huth and MacDonald led to a 35 percent drop rate. Even so, the two approaches generated very similar samples for further analysis. In our approach, 75 out of 153 usable cases (49.0%) culminated in union decertifications. For Huth and MacDonald, the pro- portion was 100 of 203 (49.3%).

Methodology The event study methodology first appeared in a study by Fama et al.

(1969). Researchers in financial economics and accounting have employed this approach ~ i d e l y . ~ The first step is to model the stock return generating p r o c e s ~ . ~ This establishes the relationship between the firm’s share price

See Brown and Warner (1980, 1985) for reviews of this approach. A stock return is a measure of stock price change. The return for an individual security for a single

period (Ri,) is defined as

where Pi, = the price of security i at time t, and Di, = dividends paid during the period.

64 / THOMAS G . PEARCE, JAMES E. GROFF, AND JOHN R. WINGENDER

and the general movements in the securities market. In this study, we employed an equally weighted CRSP market portfolio as the proxy for the market as a whole. In this way, we produced the following regression equation for the estimation period:

where Rit is the actual daily return for an individual stock i on a particular day t, R,, is the CRSP equally weighted market index return on day t, ai is the slope intercept, pi is the slope coefficient and reflects the relationship between the individual stock price movements and those of the market as a whole, and eit is the error term of the model.

For each decertification case, we estimated market model coefficients over a period running from 135 trading days until 16 trading days prior to the event. We then turned our attention to the event test periods in the second step of the process. We defined the event period to run from 15 trading days prior to the event until 15 days afterward, a period of 31 trading days counting the actual day of the event itself. For each case, we determined the actual return for each day t of the test period. We compared that return with the value predicted for that security on the basis of the firm’s (Y and /? calculated during the estimation period, controlling for the general market movements on the day in question:

where ui, is the residual value of the model, the abnormal return, and D is the event day of interest in each case.

We then calculated the average abnormal return during the event window:

N

AR, = C Uit / N, t = (D - 15) to (D + 15), i = l

(3)

where AR, is the average abnormal return on day t, and N is the number of firms in the sample.

Cumulative abnormal returns are often more interesting than the reaction on any individual day of a test period. We computed the cumulative effect of an event by summing the average abnormal returns across time. This step allowed us to consider trends. These trends may reveal patterns of economic consequences that escape notice for an individual day. The cumulative average abnormal return (CAR) for firm i is determined as follows:

Union Decertijication’s Impact on Shareholder Wealth I 65

T CARi = C ARit,

t = l (4)

where T is the number of days of the test period over which the CAR is accumulated.

We tested both the average abnormal returns and the cumulative abnormal returns for statistical significance using the t-statistic:

(AT, - 0) t . . =

SE,IN ’ statistic

where SE, is the standard error of the mean of the abnormal returns on day t.6 We calculated the t-statistic for the CAR,s using an analogous approach, substituting CAR, for AR,. We followed this approach for each of the three decertification events of interest: the date of the petition filing, the date of the bargaining unit election, and the date of the announcement of the results.

Results and Discussion The average abnormal returns associated with all the firms in the sample

address two questions. First, the immediate and significant share price response to a decertification event would reflect changes in the investors’ expectations of future cash flows as a result of that event. In the case of a decertification event, the price reaction jointly reflects investors’ assess- ments of the likelihood that the process will culminate in the departure of the union and the economic consequences that would then come about. If investor reaction is motivated by the costs of unionization as prior studies have argued (Ruback and Zimmerman, 1984; Bronars and Deere, 1990; Huth and MacDonald, 1990), then any event that signals decertification of the union in a particular firm is likely to be greeted with a positive stock price reaction. Changing expectations about the likelihood of success in the decertification process drive the stock price reaction.

The filing of a petition is the first publicized step in the decertification process. Unions historically lose their authority to represent bargaining units following the filing of decertification petitions approximately 75 per-

Standard error of the mean abnormal return is calculated as

SE, = 2 [(AR,, - m,)’ / (N - l)]”’, , = 1

where all the variables are as defined above.


cent of the time. But in roughly half of the cases where petitions lead to elections, the unions fare a little better, retaining their status as bargaining agents about half the time. In instances where the union foresees little likelihood of winning a board-conducted election, it may file a disclaimer of interest in further association with the bargaining unit and withdraw. If the unit is small in size and remote or otherwise difficult to service, it may not be cost-effective for the union business office to keep a marginal bargaining unit in the fold. Or the board may decline to assert jurisdiction in a given case for any of a variety of technical reasons, leaving the employer to refuse with impunity to treat further with the union. For present purposes, the difference in union prospects for success provides different a priori bases for investors to formulate expectations. When a petition has been filed but nothing more has had a chance to occur, the likelihood is that the union will have its bargaining certification rescinded about 75 percent of the time; but if an election is actually conducted, the overall prospects of a union ouster decline to about 50 percent. In specific cases, particular aspects of a given case may lead knowledgeable investors to expect better or weaker prospects for a union ouster. In any event, unless investors are acting irrationally, we would expect that reactions in the financial markets to the results should be confined to those situations where the eventual outcome of the process is highly uncertain or unanticipated.

For our aggregated sample of 153, we do find a significant positive reaction in share prices on the petition filing date. The abnormal return shown in Panel I of Table 1 is 0.4334 percent (t = 2.73, (Y < .Ol). However, a somewhat different picture emerges if we partition the sample into cases that eventually culminate in union decertification and those in which the union remains. If we assume that investors have assessed the prospects of decertification in each case and have accurately assigned the highest ex- pected probabilities to those situations where in fact decertification will occur, we would expect to see different average responses between the two partitioned samples. And indeed, that is precisely what we see. Panel I1 of Table 1 shows the share price reaction for the decertifying portion of the sample is highly positive, but the union-retaining portion of the sample shows no significant change.

This scenario does not preclude the misidentification at the filing date of the final outcome in the decertification process yet to unfold; it simply requires that the market agents be substantially correct in their aggregate identification of that final outcome. For the decertification sample, most firms are correctly identified, and the share prices experience a reaction in conjunction with the filing date but not with the election date. Since correctly anticipated results predominate, misspecified situations do not ap-

Union Decertification's Impact on Shareholder Wealth I 67

TABLE 1

(expressed in %) AVERAGE ABNORMAL RETURNS ON THE DATE OF THE EVENT

~~

Announcement Filing Date Election Date Date

Panel I All Firms (N = 153)

.4334** - .1462 - .0970

Announcement Filing Date Election Date Date

Retain oust Retain Oust Retain oust

Panel II Partitioned Firms .1261 .7529** -.5890* .3144 -.1376 -.0548

(NRetain = 78, &Just = 75)

'Significant at the .05 level; ** significant at the .01 level

preciably affect the overall pattern. New information can arise over the course of the decertification process, and investors can revise their expectations accordingly. Under such circumstances, we would expect that share prices adjust accordingly.

The next opportunity for measuring these revised expectations occurs at the election date. However, because of the ex post facto partitioning of the entire sample, the direction of the response is constrained by what has occurred before. For the sample that eventually does decertify, there is no basis to expect any further share price changes if the market has correctly forecast the outcome of the decertification effort. However, for firms whose fates have been misassessed and who have unexpectedly dislodged the union, we would expect to see a positive change in the share price. Panel I1 of Table 1 presents this pattern. The size of the reaction in the aggregate sample will depend on what portion of the decertification outcomes has surprised investors. Since most firms have previously experienced a positive price reaction, the average further price adjustment is not significant.

The share price reaction for firms in the RETAIN subsample that investors have misassessed should be negative, since they previously would have experienced elevated share prices. In Panel I1 we see that the aggregate reaction for this group is significantly negative, suggesting that at some time in the process leading up to the respective bargaining unit elections an appreciably large portion of these firms had been misassessed.

The final event is the actual formal disclosure of the election outcome. Only those firms for which the outcome is a surprise should experience any


reaction on this date. Since we have already witnessed significant shifts in prices within the two partitioned subsamples prior to this date, it is difficult to imagine circumstances that could cause any major share price changes in conjunction with this event. In fact, we see only insignificant reactions in both groups associated with the announcement date.

While these results analyzing the share price reactions on specific dates tend to support earlier studies, they do not tell the entire story. Of more importance than the immediate market reaction is the persistence of the price changes. We can investigate the durability of such changes by observ- ing the cumulative abnormal residuals (CARs) over the period surrounding the event. We present the CARs for periods of various duration in Table 2.

The CARs for the periods surrounding the petition dates suggest that there is no lasting gain in wealth to investors for firms that oust the union, since the share price falls back to its prepetition date level within seven trading days after the petition is filed. In fact, firms that do see a recision of the union’s representation status through the decertification process experience systematic negative performance, as indicated by the CARs.

Figures 1 ,2 , and 3 show plots of the CARs for the two subsamples for the event windows surrounding the petition date, the election date, and the announcement date, respectively. The differences between the postevent date responses between the two subsamples are quite dramatic. Although the total gain in value for each subgroup over the two-week period leading up to and including the petition date is about the same, approximately 1.3 percent, the price decline following the petition filing date is quite dissimi-

TABLE 2 CUMULATIVE AVERAGE RESIDUALS (CAR) FOR PERIODS OF VARIOUS LENGTH WITH

REFERENCE TO THE EVENT DATE (D)

Filing Date Election Date Announcement Date

Period CAR t p CAR t p CAR t P ~

D-15 to D-1 D-10 to D-1 D-5 to D - l D D + l to D + 5 D + l to D+10 D + l to D+15 D-15 to Da

0.8493 0.4427 0.1283 0.4334 - ,8623 - 1.0612 -1.2782

1.2817

1.48 0.140 0.99 0.323 0.40 0.692 2.73 0.007

-2.67 0.009 -2.57 0.011 -2.62 0.010

2.15 0.033

~ ~~

0.1270 0.22 0.2472 0.51 0.1616 0.47

-0.1462 -0.79 0.2488 0.67 0.5975 1.30 0.6413 1.12

-0.0191 -0.03

0.829 0.609 0.640 0.432 0.503 0.195 0.263 0.974

-0.0586 0.1631 0.2567

0.1807 0.6083 0.3667

- 0.0970

-0.1555

-0.10 0.921 0.32 0.748 0.69 0.490

-0.63 0.528 0.57 0.568 1.34 0.181 0.69 0.490

-0.26 0.792

aThis interval represents a sixteen-day period, including the event date.

-15 -10 -5 0 +5 +10 +15

Relative Days

+ Retain Union + Oust Union

Figure 2 CARS Election Date


Figure 3 CARS Announcement Date

CAR

2;

I

+ Retain Union + Oust Union

lar. While the subgroup that retains the union presence loses about 50 percent of the total price run up in the week following the petition date, the group that ousts the union loses the entire prefiling gain plus an additional 0.6 percent of its beginning value. Furthermore, the stock price performance of the subsample that loses union representation never matches that of the group retaining the union in the period surrounding the election date nor that surrounding the announcement date.

The subsample that retains the union, on the other hand, shows consis- tently positive cumulative abnormal returns after the election and continu- ing through the fifteen days following the date of the official announcement by the board. Figure 3 graphically portrays how disparate the performances of the two partitioned subsamples are in the period after the announcement date. The CAR difference is significant on eight of the fifteen days, and is nearly significant on two other days in this brief interval. These results suggest that the stock market is rewarding the firms that retained their unions, since over the fifteen days following the announcement there was nearly a 2 percent relative price performance difference between firms that ousted their unions and those that retained them.

Union Decertijication’s Impact on Shareholder Wealth I 71

Conclusion Prior research has shown a pattern of negative share price responses to

the arrival of a union presence in a firm. Researchers have argued that such financial market responses reflect the expectations by investors that unions will impose higher labor costs and more rigid work rules on such employers. Such arguments ignore the possibility that there may be high costs associated with a sudden change in managerial discretion, regardless of whether that change is associated with the arrival or the departure of a union presence. Management that is used to operating in a nonunion environment may indeed incur high costs when it is suddenly required to deal with a unionized labor force. But as we point out, these structural changes cannot be segre- gated from the changeover cost effects and investor uncertainty about management’s ability to make the change, since both contributions to investor discomfort operate in the same direction. However, in episodes of union decertification these costs are in opposite directions. According to the labor cost argument, labor costs should fall (or at least rise less rapidly) when the union has departed. Yet, because the switch to a nonunion work force creates changeover costs of precisely the same magnitude as unionization but opposite in direction from labor costs, decertification events offer an opportunity to segregate these two cost effects.

Our results suggest that the structural change costs may be of more importance than the labor cost effects. We do report evidence both on the petition filing date for firms that oust the union and on the election date for firms that retain the union of stock trading consistent with the labor cost argument. The former group experiences a significant price increase and the latter a significant price decrease on the event date in question. However, within a single week thereafter, all of these price effects disap- pear. Perhaps stock traders who bid against the union in these instances may be trading more on prejudice than on an objective assessment of the real impact of the change in union status for the firm, an example of what Black (1986) calls “noise trading.”

We also report here a prolonged and significant positive share price response associated with union retention after a decertification challenge. We interpret this result as suggesting that the stock market is rewarding those firms that do not incur the instabilities and uncertainties associated with a reversal of their unionized status.

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Union Decertifications's Impact on Shareholder Wealth