Alexander Muravyev (IZA, Bonn)
Irina Berezinets (GSOM, St. Petersburg)
Yulia Ilina (GSOM, St. Petersburg)
Graduate School of Management, St. Petersburg State University
April 2010
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Owners, managers, and workers: an empirical study of the link between corporate governance and employment policies of firms by Alexander Muravyev, Irina Berezinets, and Yulia Ilina
This project is supported by the Moscow Public Scientific Foundation (MPSF), sponsored by the United States Agency for International Development (USAID).
The opinions expressed in this presentation are the authors' opinions and may differ from the opinions of USAID and/or MPSF.
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Pagano and Volpin (2008) on the division of economics into subdisciplines:
“ A few years ago, the typical financial economist would have recoiled at the idea that finance may have something to do with labor relations or trade unions, and the typical labor economist would have dismissed as bizarre that shareholder protection or corporate governance might be relevant for labor economics.”
But “… firms need financiers and managers as well as workers, and it would be surprising if the relationships between any two of these parties were not to affect the third one as well, and in turn be affected by its behavior .”
The literature is scarce. A handful of studies link corporate governance and employment relations in firms using the agency perspective
(managers as agents of shareholders).
3

I. Managers may extract certain private benefits from paying workers more and building more friendly labor relations in general.

Managers’ non-pecuniary private benefits may include “the attractiveness of the secretarial staff, the level of employee discipline,
…, personal relations (‘love’, ‘respect’, etc.) with employees” (Jensen and Meckling 1976 JFE).

Higher pay can also reduce the CEO’s effort in wage bargaining with trade unions. While the full cost of wage bargaining is borne by the
CEO, she only receives a small fraction of the gains from a lower total wage.
II. Higher employee compensation can protect the CEO’s job or private benefits of control (those not directly related to labor relations) against raiders.
 Workers and trade unions can be turned into an anti-takeover mechanism: the inability to renege worker wages transforms the firm into an unattractive takeover target (Pagano and Volpin, 2005 JF).
4


Bertrand and Mullainathan (1999 RAND, 2003 JPE): there is a significantly larger increase in the wage bill for US firms incorporated in states that passed anti-takeover laws in the 1980s. This may be interpreted as evidence that poorly governed CEOs want to “enjoy the quiet life” through lower effort wage bargaining.
 Landier, Nair, and Wulf (2007 RFS): firms in the US are less likely to lay off workers located geographically closer to corporate headquarters. Part of this behavior seems to reflect private benefits that come from interacting with workers and communities close to corporate headquarters.
 Pagano and Volpin (2005 JF): managers collude with workers by paying them above market wages to thwart hostile takeover attempts.
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
Atanassov and Kim (2009 JF) document the importance of interaction among management, labor, and investors in shaping corporate governance using cross-country data. They find that strong union laws protect not only workers but also underperforming managers.
Weak investor protection combined with strong union laws are conducive to worker –management alliances, wherein poorly performing firms sell assets to prevent large-scale layoffs, garnering worker support to retain management.
 Cronqvist, Heyman, Nilson, Svaleryd, and Vlachos (2009 JF) use data from Sweden to find that CEOs with more control pay their workers more, but financial incentives through cash flow rights ownership mitigate such behavior. Entrenched CEOs pay more to employees closer to them in the corporate hierarchy, geographically close to the headquarters, and associated with conflict-inclined unions. Interpretation: entrenched CEOs pay more to enjoy private benefits such as lower effort wage bargaining and improved social relations with employees.
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
This paper aims to relate a firm’s employment policies (wages, arrears) to the scale of the private benefits of control, PBC (~ the severity of corporate governance problems in the firm: “stealing” + “shirking”) in a more direct way than the previous studies.
 Most of the available evidence is indirect: For example, Cronqvist et al.
(2009) relate workers’ wages to CEOs’ ownership of voting and cash flow rights in dual class stock firms and find positive and negative associations, respectively.
 The major challenge in the project is the estimation of PBC, which are intrinsically unobservable.
 We do not claim causality in this study: the focus is on the correlation between corporate governance and employment policies of firms.
Essentially, the sign interpretation of the results.
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

PBC are a centerpiece of the recent literature on corporate finance
(Dyck and Zingales 2004 JF). However, little progress in measuring
PBC: by their very nature, private benefits of control are difficult to observe and even more difficult to quantify. If PBC could be evaluated they would immediately loose their “privacy” and minority shareholders could bring in a lawsuit against the corporation or the controlling owner.
1.
Two ways to obtain a proxy for PBC (always non-random samples!):
The value vote approach, based on comparing prices of voting and nonvoting stocks of same companies. The difference in prices, the so-called voting premium, reflects the price a potential bidder would be willing to pay to atomistic holders of voting stock in order to establish control over the company and thus is correlated with the size of control benefits
(Rydqvist, 1997).
2.
The controlling block sales approach: PBC are the difference between the price of shares in transactions involving control block change and the share price in the stock market after the announcement of the control block sale (Barclay and Holderness, 1989).
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


Obtain a sample of dual-class stock firms traded in the market;
Compute a proxy for PBC;
Relate this proxy to the employment policies of firms.
 We analyze data from Russia, so far, from 1997-2004. This is an interesting case per se, but the focus on Russia also provides two important advantages from a pure research perspective:
 Extremely large variation, both cross-sectional and over time, in key labor market and corporate governance variables.
 Large number of exogenously created dual-class stock companies (due to privatization regulations of the early 1990s). About 150 dual-class stock companies are traded in 2000.
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



Huge economic shock of the 1990s with GDP falling by about 45%.
Only modest effect on the level of employment and on the unemployment rate (never exceeded 14%).
Labor market adjustment comes primarily via wages (facilitated by high inflation rates) and non-standard mechanisms, such as wage arrears.
While there are various interpretations of this adjustment path (the
Russian labor market a is competitive and flexible or even “a neoclassical dream” (Layard and Richter, 1994); or, alternatively, very rigid due to high separation and hiring costs, etc.), the key is the remarkable variation of the labor market variables, both over time and across space.
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ILO unemployment rate, % Gross monthly wages, RUR
16
14
12
10
8
6
4
2
0
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 year
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 year
Change in real wages, year to year%
30
20
10
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
-10
-20
-30 year
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Arrears volume, bln. RUR No. of firms having wage arrears, thnds
80
70
60
50
40
30
20
10
0
140
120
100
80
60
40
20
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 year
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 year
Number of workers experiencing wage arrears, mln
25
20
15
10
5
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 year
12

ILO unemployment rate by region in 2000, %
35
30
25
20
15
10
5
0
1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 regions
Nominal wages by region in 2000, RUR
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 region
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




Severe governance failures with many instances of outright expropriation of shareholders, especially in the 1990s.
Shleifer and Vishny (1997): in the mid-1990s, Russian managers could appropriate as much as 99% of firms’ profits.
Goetzmann et al. (2003): Russia is a “Wild West” of corporate control.
These governance risks are reflected in the unusually high – by international comparisons - values of the voting right, which is one of the measure of PBC (up to 200% premium on voting shares).
Substantial improvements in the corporate governance in the early
2000s.
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Premium on common shares: RTKM
Premium on common shares: SNGS
350%
300%
250%
200%
150%
100%
50%
0%
2/
9/
1996
7/
4/
1997
10/
11/
1997
19/
06/
1998
22/
01/
1999
27/
08/
1999
3/
4/
2000
3/
11/
2000
15/
06/
2001
18/
01/
2002
26/
08/
2002
2/
4/
2003
4/
11/
2003
16/
06/
2004
24/
01/
2005
29/
08/
2005
350%
300%
250%
200%
150%
100%
50%
0%
2/
9/
1996
7/
4/
1997
10/
11/
1997
19/
06/
1998
22/
01/
1999
27/
08/
1999
3/
4/
2000
3/
11/
2000
15/
06/
2001
18/
01/
2002
26/
08/
2002
2/
4/
2003
4/
11/
2003
16/
06/
2004
24/
01/
2005
29/
08/
2005
Premium on common shares: EESR
350%
300%
250%
200%
150%
100%
50%
0%
2/
9/
1996
7/
4/
1997
10/
11/
1997
19/
06/
1998
22/
01/
1999
27/
08/
1999
3/
4/
2000
3/
11/
2000
15/
06/
2001
18/
01/
2002
26/
08/
2002
2/
4/
2003
4/
11/
2003
16/
06/
2004
24/
01/
2005
29/
08/
2005
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





Two separate equations:

 the “finance” equation (CG conflict = size of private benefits of control) the “labor” equation describing wage policies of firms.
Where
Log( Wage it
)=
VP it
= α + X it

+ Z

+
 it it

+
 it
+ ψ t
+ v it
+ φ t
 it and
 it
+ u it
(2)
(3) are “managerial actions” wrt workers and shareholders.
If we could observe and measure
 it and
 it
, we would be done.
However, these quantities are unobserved.
Therefore, as we have to omit these variables when estimating (2) and
(3), the “managerial actions” show up in the residuals.
We thus take the residuals from the two equations (they are proxies for managerial actions!) and check how they are related!
We regress residuals from (2) on residuals from (3) and also check if the relationship is influenced by control structure in the firm. Interactions.
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

Derived from the voting premium model by Zingales (1994, 1995):
VP = Ф ( B / y ) (1/

) , where
VP = Price(voting share)/Price(non-voting share) - 1,
B is the size of the private benefits of control, y – the value of cash flow rights,
 – the fraction of voting shares outstanding, and
Ф is the probability of a control contest.
In logs, (1) is transformed into an additive form. Unobserved B / y becomes a part of the error term. The residual can be regarded as a proxy for the private benefits of control.
Additional controls: liquidity, industry dummies + a bunch of differential characteristics of Russian preferred shares (dividend rules, enfranchisement, ADR issue, etc.) + time dummies.
17

 Relates wages (wage growth, non-wage payments, wage arrears as a fraction of payroll) on a set of firm-specific variables, including:








Industry dummies
Regional dummies
Time dummies
Capital intensity
Firm performance (labor productivity, profitability)
Firm size
Local labor market characteristics (unemployment rate, monopsony measure, average wages in a region).
The monopsony measure is constructed by dividing the number of workers in the form to the population of the town the firm (its headquarters) is located.
18




Stock market data on all dual-class stock companies traded in the
Russian Stock Exchange in 1997-2004 ( www.rts.ru
), over 200 firms.
The companies’ employment and financial data, from their annual financial reports from 1996-2004 (Alba, Gnosis, Skrin databases).
Extra data characterizing local labor markets (unemployment rates, wages, etc.).




Excluded: a dozen of companies with non-voting shares convertible into voting shares (not good for measuring PBC).
About 600 observations in total. Firm-level data.
1 to 5 percent of outliers are winsorized or deleted (the results are not much affected by the exact cut-off).
Wages, assets, etc. are CPI deflated.
19

Distribution of observations by industry
Power utilities
Oil&gas
Metallurgy
Chemical
Machine building
Light industry
Telecoms
Distribution of observations by federal districts
All Federal
Central
North-Western
Southern
Volga
Urals
Siberian
Far Eastern
Distribution of observations by years year 1997 year 1998 year 1999 year 2000 year 2001 year 2002 year 2003 year 2004
20

2.5
Voting premium
2.0
1.5
1.0
0.5
0.0
1997 1998 1999 2000 year
2001 2002 2003 2004
21

60
50
40
30
20
10
0
90
80
70
1997
Annual wages per worker (thousand 2000 RUR)
1998 1999 2000 year
2001 2002 2003 2004
22

Shapley
Control
Downer
Cont_sh pi_inverted
A
Ln(VP)
0.985***
0.014
B
Ln(VP)
-0.489***
0.209
C
Ln(VP)
-0.007***
-0.008
D
Ln(VP)
-0.475***
0.007
LiquidityCommon 0.898*** 0.880*** 0.912*** 0.904***
LiquidityPreferred -0.939*** -0.894*** -0.899*** -0.881***
Veto_power
Ddividend
Dividend10
0.020
-3.624***
-0.217
0.024
-3.771***
-0.217
0.029
-3.651***
-0.234*
0.046
-3.847***
-0.272*
ADR
Vote
Lower_bound
Time dummies
Sectoral dummies
Reg. dummies
Intercept
R2
N
0.035
0.107
0.522**
YES
YES
YES
-0.273
.40
594
0.010
0.100
0.474*
YES
YES
YES
0.238
.41
594
0.021
0.108
0.456*
YES
YES
YES
0.093
.40
594
0.016
0.104
0.526**
YES
YES
YES
0.238
.41
594
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A ln(Wage)
B ln(Social)
Monopsony
ILO_unemploym
-0.032
0.007
-0.035
0.003
Log(Reg_wage) 0.674*** 0.606***
Reg_arrears 0.280 0.284
C
Dwage
-0.005
-0.018
-0.021
-0.180
E
Arrears
0.001
0.002
-0.003
0.511***
Log(Sales)
Power utilities
Metallurgy
Chemical
0.009 0.011
-0.172*** -0.114*
-0.433*
-0.098
-0.258
-0.051
-0.002
-0.015
0.216
0.053
0.002
0.004
0.011
-0.019**
Machine building -0.361*** -0.247**
Light industry -0.246 -0.308
Telecoms
0.048
0.103*
0.004
-0.001
-0.336*** -0.280*** -0.042* -0.040***
Year 1998
Year 1999
Year 2000
0.062
0.053
-0.034
0.102** 0.316***
0.077* 0.085**
-0.009
-0.014**
-0.006 0.337*** 0.004
Year 2001
Year 2002
Year 2003
Year 2004
Reg. dummies
Intercept
R2
N
-0.002
0.120*
0.155**
-0.083
-0.008
-0.067
0.240***
YES
-0.031
YES
2.099*** 1.023**
.71 .62
594 594
0.353*** 0.008
0.346*** -0.002
0.315*** -0.035***
0.361***
YES
0.015
.40
594
-0.009
YES
0.059
.42
594
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VP_resid
VP_resid X Control
Control
VP_resid X Cont_sh
Cont_sh
VP_resid X Downer
Downer
VP_resid X Downer_1
VP_resid X Downer_2
VP_resid X Downer_3
VP_resid X Downer_4
Intercept
Test VP_resid X Downer_1=
VP_resid X Downer_4
R2
N
A B C D
-0.009 0.134** 0.158*** 0.059
-0.155**
0.083
-0.178***
0.104*
-0.001
0.003**
0.000 -0.075 -0.096* -0.105**
.00042
594
.019
594
.022
594
.033
594
E
0.096
-0.021
-0.012
-0.029
-0.001
F(1,140)=1.97
Prob>F=0.1629
.0059
594
Control=dummy for majority control; Cont_sh=dummy (majority control or owner1owner2 >20%), Downer = owner1-owner2; Downer_1, etc. – quartiles of Downer
25

VP_resid
VP_resid X Control
Control
VP_resid X Cont_sh
Cont_sh
VP_resid X Downer
Downer
VP_resid X Downer_1
VP_resid X Downer_2
VP_resid X Downer_3
VP_resid X Downer_4
Intercept
Test VP_resid X Downer_1=
VP_resid X Downer_4
R2
N
A
-0.157
0.000
.00077
594
B C D
-1.825* -2.194** -1.560*
1.829*
-0.262
2.204**
-0.491
0.248
.0094
594
0.467
.012
594
0.033*
-0.002
0.114
.012
594
E
-2.112**
-0.348
0.217
0.514
0.030
F(1,140)=4.09
Prob>F=0.0452
.015
594
Control=dummy for majority control; Cont_sh=dummy (majority control or owner1owner2 >20%), Downer = owner1-owner2; Downer_1, etc. – quartiles of Downer
26






Corporate governance and employment policies of firms are related.
Workers seem to benefit (from higher wages, lower wage arrears) in firms with severe corporate governance problems. Expropriation of investors implies more generous employment policies, and vice versa.
This result holds, however, only when firms are not majority owned
(ownership structure is relatively dispersed).
When firms are majority controlled, there is no apparent relationship between the policies of managers (controlling shareholders) towards workers on the one hand and towards minority shareholders on the other hand.
The findings are in accord with several previous studies showing that expropriation of shareholders and employment policies may be linked via the market for corporate control.
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