Labor Representation in Governance as an
Insurance Mechanism
E. Han Kim, Ernst Maug and Christoph Schneider
Presentation at the Ackerman Conference on Corporate Governance
Bar-Ilan University, 17.12.2012
Motivation
Question: What is the impact of labor representation on boards
 on employment
 on wages
 on economic efficiency?
Contrasting views
 Efficient contracting: Labor representation supports efficient insurance contracts
 Workers receive insurance in exchange for lower wages (e.g., Baily (1974), Harris &
Holmstrom (1982) , Holmstrom (1983))
 Labor representation prevents ex-post expropriation
 Rent seeking: Labor representation protects rents of workers and managers
 Jensen & Meckling (1979), Pagano & Volpin (2005), Cronqvist et al. (2009)
Views on Labor Representation
The Chicago view:
“The campaigns for ‘worker participation’ or ‘industrial democracy’ or codetermination
on boards of directors appear to be attempts to control the wealth of stockholders'
specialized assets … a wealth confiscation scheme.” (Alchian, 1984)
The European view:
“Allen and Gale (2002) argue that in incomplete, imperfect markets, a stakeholder
system of corporate governance that stresses cooperation between management and
employees may allocate resources more efficiently in the long run than a shareholder
system.” (Fauver and Fuerst, 2006, p. 674)
World Map of Labor Representation on Boards
Institutional background Codetermination in Germany
 Up to 500 employees in Germany:
 no worker representation
 More than 500 up to 2000 employees in Germany:
 1/3 of the board members have to be worker representatives
 Board size between 3 and 21 can be chosen (multiple of 3)
 More than 2000 employees in Germany:




1/2 of the board members have to be worker representatives
Casting vote of the chairman (shareholder representative)
Board size 12, 16 or 20 (cutoff:s 10,000 and 20,000 employees)
Exception in the iron, coal, and steel industry: one neutral member in firms with more
than 1000 employees (board size: 11, 15, 21)
Research questions
What is the impact of parity codetermination on
 employment: do parity-codetermined firms provide more insurance to workers
against adverse shocks?
 wages: to the extent that the workers in parity-codetermined firms recieve
insurance, do they pay an insurance premium?
 firm risk: are parity-codetermined firms more risky because they provide insurance
to their workers?
Sample
 184 large listed German corporations (1990-2009)
 All DAX and MDAX companies
 Most publicly available information (governance, stock market, balance sheet, and P&L
data)
 IAB sample of all German businesses (1975-2008)
 Detailed establishment level data on industry, location, employment, wages, education,
age, (nationality)
 In total approx. 33.4 million establishment-year observations for period 1990-2008

34,000 establishments matched to 142 of our 184 firms
 Matching on company and subsidiary names and addresses for the year 2006 (2004,
2005)
Research design
 Compare how negative shocks affect employees and
 firms with parity codetermination vs.
 firms with less or no representation on the board
 Difference-in-difference model:
y ijklt = a i + a t + a k + dParity jt + qShock lt + b Parity jt ´ Shock lt + g X ijt + eijklt





i indexes establishments
j indexes firms
k indexes state of location
l indexes industry
t indexes time
Definition of shocks
 Shock needs to be
 large enough to have a significant impact
 frequent enough to permit identification
 exogenous to the firm
 We use non-sample firms with establishments in Germany (IAB employment data)




Based on >30 million establishment-years
Industry defined as 3-digit NACE (subsector), similar to NAICS
Shocklt = 1 in industry l if employment in the industry decreases by at least 5%
Shocklt = 1 in industry l only if employment growth ≤ 0 in year t+1 (persistence)
Shocks: Examples
 Shocks can be long-lived:
 2-year shocks: Shocklt+1 = 1 if Shocklt = 1 and employment growth ≤ 0 in year t+1
 4-year shocks: Shocklt+j = 1 if Shocklt = 1 and employment growth ≤ 0 in year t+j
for j=1, 2, 3  baseline case
t
Case A
Case B
Case C
Case D
Employment growth
Shock (4-year interval)
Employment growth
Shock (4-year interval)
Employment growth
Shock (4-year interval)
Employment growth
Shock (4-year interval)
1
2
3
4
5
-6%
-2%
0%
2%
-1%
1
1
1
0
0
-10%
2%
0%
2%
-1%
0
0
0
0
0
-10%
-2%
0%
-2%
-1%
1
1
1
1
0
-10%
-2%
0%
-5%
-1%
1
1
1
1
0
Distribution of shocks across time
0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
1992
1993
1994
1995
1996
1997
1998
1999
2 years
2000
2001
2002
up to 4 years
2003
2004
2005
2006
2007
2008
Hypothesis 1
Parity codetermination is a commitment device. With parity
codetermination, workers receive full insurance against
adverse shocks to employment.
Do parity firms protect their employees?
Shock × Parity
Shock
Parity
(1)
0.2000
(3.00)
-0.1860
(-3.16)
-0.1780
(-1.48)
LogPlantAge
LogSales
Leverage
LogEmployees
LogSales²
LogEmployees²
adj. R²
Observations
0.908
52,756
F-Test: Shock × Parity+Shock=0
0.675
No
Yes
No
Year F.E.
Establishment F.E.
State F.E.
Dependent variable: log number of employees
(2)
(3)
(4)
(5)
(6)
0.1900
0.1700
0.1630
0.1470
0.1340
(3.03)
(3.09)
(2.17)
(2.37)
(1.82)
-0.1760
-0.1390
-0.1760
-0.1370
-0.1460
(-3.07)
(-2.85)
(-2.62)
(-2.54)
(-2.34)
-0.0180
-0.0400
-0.1030
-0.1070
-0.1000
(-0.21)
(-0.56)
(-0.88)
(-1.08)
(-0.91)
0.0100
0.1200
0.0080
0.1010
0.0220
(0.40)
(4.17)
(0.33)
(4.05)
(0.86)
-0.0450
0.1040
-0.1170
0.0110
0.4310
(-1.02)
(2.31)
(-2.65)
(0.29)
(1.47)
-0.1000
-0.1740
-0.0310
-0.0710
0.0000
(-1.21)
(-2.36)
(-0.46)
(-1.08)
(0.00)
0.4450
0.4080
0.5890
(3.74)
(3.93)
(1.31)
-0.0120
(-1.70)
-0.0080
(-0.30)
0.913
0.916
0.917
0.919
0.917
51,188
51,188
51,188
51,188
51,188
0.829
No
Yes
Yes
0.244
Yes
Yes
Yes
0.729
No
Yes
Yes
0.729
Yes
Yes
Yes
0.737
No
Yes
Yes
(7)
0.1380
(2.20)
-0.1270
(-2.51)
-0.1030
(-1.12)
0.1020
(4.13)
0.1090
(0.34)
-0.0670
(-0.79)
0.6490
(1.48)
-0.0020
(-0.29)
-0.0130
(-0.49)
0.92
51,188
0.714
Yes
Yes
Yes
Do parity firms protect their employees?
Employment changes after adverse industry shocks
5%
All employees
0%
-5%
-10%
-15%
Non-parity
Parity
Do parity firms protect their employees?
Employment changes after adverse industry shocks
5%
All employees
White collar
0%
-5%
-10%
-15%
Non-parity
Parity
Do parity firms protect their employees?
Employment changes after adverse industry shocks
5%
All employees
White collar
Blue collar
0%
-5%
-10%
-15%
Non-parity
Parity
Do parity firms protect their employees?
Employment changes after adverse industry shocks
5%
All employees
White collar
Blue collar
Unskilled blue
collar
0%
-5%
-10%
-15%
Non-parity
Parity
Hypothesis 2
Firms with parity codetermination pay on average lower
wages.
Do employees pay an insurance premium?
Dependent variable
Parity
LogPlantAge
LogSales
LogMedianEmpAge
adj. R²
Observations
Year F.E.
Industry F.E.
Establishment F.E.
State F.E.
County F.E.
Median wage of unskilled
employees
Median wage of skilled
employees
Median wage of highly
skilled employees
(2)
-0.0560
(-1.66)
-0.0010
(-0.06)
0.0140
(0.80)
(3)
-0.0570
(-1.69)
0.0000
(-0.04)
0.0140
(0.81)
(5)
-0.0120
(-0.64)
-0.0160
(-1.90)
0.0130
(1.18)
(6)
-0.0130
(-0.68)
-0.0160
(-1.88)
0.0130
(1.17)
(8)
-0.0310
(-2.03)
0.0020
(0.66)
0.0480
(4.42)
(9)
-0.0300
(-2.03)
0.0020
(0.74)
0.0480
(4.36)
0.1680
(5.35)
0.812
84,751
Yes
No
Yes
Yes
No
0.1660
(5.32)
0.813
84,751
No
No
Yes
No
Yes
0.1370
(4.46)
0.894
233,396
Yes
No
Yes
Yes
No
0.1380
(4.49)
0.895
233,396
No
No
Yes
No
Yes
0.1400
(7.16)
0.832
81,817
Yes
No
Yes
Yes
No
0.1400
(7.06)
0.833
81,817
No
No
Yes
No
Yes
Is there any wage compression?
Dependent variable
Parity
LogPlantAge
LogSales
LogMedianEmpAge
adj. R²
Observations
Year F.E.
Industry F.E.
Establishment F.E.
State F.E.
County F.E.
3rd - 1st quartile wage scaled by
median wage of all full-time employees
(1)
(2)
(3)
-0.0050
-0.0050
-0.0050
(-0.71)
(-0.74)
(-0.73)
0.0250
0.0240
(2.56)
(2.52)
0.0180
0.0180
(2.18)
(2.15)
-0.1060
-0.1040
(-4.15)
(-4.11)
0.743
0.749
0.75
53,909
53,909
53,909
Yes
Yes
No
Yes
No
No
Yes
Yes
Yes
Yes
Yes
No
No
No
Yes
Hypothesis 3
Parity-codetermined firms suffer larger reductions of
profitability after adverse shocks than non-parity firms.
Performance of codetermined firms (1)
Dependent variable: ROA
(1)
(2)
(3)
(4)
-0.0300
-0.0310
-0.0320
-0.0320
(-2.22)
(-2.27)
(-2.34)
(-2.41)
-0.0130
-0.0260
-0.0140
-0.0260
(-1.07)
(-2.13)
(-1.15)
(-2.14)
-0.0110
-0.0140
-0.0080
-0.0110
(-1.32)
(-1.75)
(-0.95)
(-1.42)
0.488
1,815
0.501
1,815
0.493
1,815
0.512
1,815
Firm F.E.
Yes
Yes
Yes
Yes
All linear conrols
Yes
Yes
Yes
Yes
Squared controls
Year F.E.
No
No
Yes
Yes
No
Yes
No
Yes
FirmShock × Parity
FirmShock
Parity
adj. R²
Observations
Performance of codetermined firms (2)
(1)
FirmShock × Parity
Dependent variable: Log TobinsQ
(2)
(3)
(4)
-0.1380
-0.1290
-0.1090
-0.0920
(-2.62)
(-2.47)
(-2.10)
(-1.80)
-0.0740
-0.1010
-0.0660
-0.0750
(-1.62)
(-2.24)
(-1.48)
(-1.70)
Parity
0.0450
0.0340
0.0460
0.0310
adj. R²
0.645
0.666
0.658
0.682
Observations
1,885
1,885
1,885
1,885
Firm F.E.
Yes
Yes
Yes
Yes
All linear conrols
Yes
Yes
Yes
Yes
Squared controls
No
No
Yes
Yes
Year F.E.
No
Yes
No
Yes
FirmShock
Performance of codetermined firms (3)
Dependent variable: CAPM Beta
(1)
(2)
(3)
(4)
0.2830
0.2120
0.2750
0.2530
(2.13)
(1.86)
(2.06)
(2.21)
0.0140
-0.1270
0.0110
-0.1540
(0.12)
(-1.27)
(0.09)
(-1.54)
0.0740
0.0470
0.0670
0.0330
(1.47)
(1.11)
(1.32)
(0.78)
0.406
1,675
0.58
1,675
0.408
1,675
0.584
1,675
Firm F.E.
Yes
Yes
Yes
Yes
All linear conrols
Yes
Yes
Yes
Yes
Squared controls
Year F.E.
No
No
Yes
Yes
No
Yes
No
Yes
FirmShock × Parity
FirmShock
Parity
adj. R²
Observations
Conclusion
 Employees of parity-codetermined firms receive substantially more employment
insurance
 Only skilled blue-collar and white-collar workers benefit
 Unskilled workers receive no protection
 Only highly-qualified employees pay an insurance premium
 Skilled blue-collar employees enjoy insurance without paying a premium
 Parity-codetermined firms have significantly larger operating leverage
 Larger declines in ROA and Tobin‘s q, increase in CAPM beta