Finance and labor:
an overview
1
Marco Pagano
University of Naples Federico II, CSEF,
EIEF and CEPR
F IR N C o r po r ate F i n an ce Wo r k s ho p
S ydne y, 14 O ct obe r 20 13
Expanding research field
2

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.
3
Issue no. 1:
corporate ownership and
employment risk
Which firms are better at insuring employees?
4
 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…
French and U.S. evidence
5
 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).
Worldwide evidence
6
 Ellul, Pagano and Schivardi (2013) use data from 41 countries
to investigate if employment and wages respond to sales shocks
differently between
o 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
Firm-level international data
7
 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
Country-level data
8
 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)
Employment regression
9
 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
Employment insurance: industry shocks
10
Δ Industry Sales
Family Firms
Δ Industry Sales  Family
Firms
Δ Industry Sales  Unemployment
Security
Δ Industry Sales  Family
Firms  Unemployment
Security
Δ Industry Sales  Family
Firms  Labor Market
Tightness
Control Variables
Fixed Effects
Year Dummies
R2
(1)
(2)
(3)
(4)
0.1083**
(2.58)
0.0253
(1.27)
0.0906**
(2.27)
0.0174
(1.21)
0.0722**
(2.10)
0.0101
(1.07)
0.0863**
(2.39)
-0.0991***
(-2.81)
-0.0898**
(-2.49)
0.0314
(1.46)
0.1928**
(2.10)
-0.0659**
(-2.20)
0.0415
(1.44)
0.1399*
(1.80)
-0.0750**
(-2.40)
0.0259
(1.24)
0.1604*
(1.88)
-
0.0049
(1.28)
Yes
Yes
Yes
Yes
CountryIndustry
Yes
0.45
CountryIndustry
Yes
0.49
CountryIndustry
Yes
0.50
Firm
Yes
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
12
 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
Wage insurance: industry shocks
13
Δ Industry Sales
Family Firms
(1)
(2)
(3)
(4)
0.0426***
(3.12)
0.0391***
(2.82)
0.0340**
(2.53)
0.0427**
(2.65)
-0.0104*
(-1.90)
-0.0095*
(-1.70)
-0.0051
(-1.52)
-
0.0182**
(2.61)
0.0109*
(1.92)
0.0233**
(2.35)
-0.0186*
(-1.70)
-0.0212
(1.57)
0.0580*
(1.74)
0.0662
(1.50)
Δ Industry Sales  Family Firms
Δ Industry Sales  Unemployment Security
Δ Industry Sales  Family Firms 
Unemployment Security
Firm Control Variables
Fixed Effects
Year Dummies
R2
Yes
Yes
Yes
Yes
CountryIndustry
Yes
CountryIndustry
Yes
CountryIndustry
Yes
Firm
0.10
0.12
0.12
0.12
Yes
Is employment insurance priced?
14
(1)
(2)
(3)
(4)
-0.0921**
(-2.45)
0.0047**
(2.18)
-0.0541**
(-2.28)
0.0049**
(2.05)
-0.0380**
(-2.04)
0.0041*
(1.89)
0.0058**
(2.28)
0.0091
(1.01)
No
0.0087
(0.93)
Yes
0.0030
(0.92)
0.0072
(0.85)
Yes
0.0170
(1.34)
Yes
CountryIndustry
CountryIndustry
CountryIndustry
Firm
Year Dummies
Yes
Yes
Yes
Yes
R2
0.08
0.09
0.11
0.14
Family Firms
Unemployment Security 
Family Firms
Financial Development 
Family Firms
Unemployment Security
Firm Control Variables
Fixed Effects
Is employment insurance priced? (2)
15
 Firms that provide less employment insurance pay higher real wages
Vertical axis:
firm-level
wage net of
industry,
country and
time effects
Horizontal axis:
firm-level estimate
of sales shocks
“pass-through”
(inversely related
to employment
insurance)
16
Issue no. 2:
capital structure and wage bargaining
Theoretical literature
17
 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
Evidence on debt and wages
18
 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
Evidence on debt and workers’ insurance
19
 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
Evidence on debt and unions
20
 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)
International evidence on debt and EPL
Effect of Employment Protection on Corporate
Debt
21
0.06
NZ, UK
0.04
0.02
NL, DE, DK, AT, AU
JP
0
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
ES
-0.02
SE
-0.04
IE
-0.06
NO, IT, BE
FI
CA
US, CH, PT, GR
-0.08
FR
Creditor Rights
-0.1
Source: estimates of Simintzi, Vig and Volpin (2009), Table VII, Column 3
Assessing existing evidence
22
 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

Workers’ protection in bankruptcy
23
 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.
Measuring worker seniority in bankruptcy
24
 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
4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
Austria
Finland
Germany
Ireland
Slovak republic
Australia
Denmark
Luxembourg
Netherlands
New Zealand
Sweden
Switzerland
Turkey
USA
Belgium
Canada
Greece
Hong Kong
Iceland
Italy
Japan
Korea
Malaysia
Singapore
South Africa
Thailand
UK
Spain
Argentina
Norway
Poland
Brazil
Czech Republic
France
Hungary
India
Indonesia
Mexico
Salary priority around the world
25
Salary priority
Public guarantees around the world
26
 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
Unemployment benefits around the world
27
60
50
1971
40
1981
30
1991
2001
20
2007
Denmark
Portugal
Belgium
France
Ireland
Spain
Finland
Netherlands
Norway
Switzerland
Sweden
Italy
Austria
New Zealand
Germany
Australia
USA
Greece
Canada
Japan
0
UK
10
Average unemployment benefit replacement rates for 2 earnings levels, 3 family
situations and 3 unemployment durations, sorted by 2007 level. Source: OECD.
Merge these indicators with company data
28
 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
Leverage and workers’ protection in bankruptcy
29
Dep. Variable: Book Leverage
(1)
(2)
(3)
(4)
(5)
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
94,056
94,056
94,056
94,056
94,056
Salary Priority
No. of observations
30
Issue no. 3:
labor and corporate governance
Employees’ ownership and control rights
31
 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)
2
Australia
Austria
Belgium
Canada
Czech Republic
Denmark
Finland
France
Germany
Greece
Hungary
Ireland
Italy
Japan
Korea
Mexico
Netherlands
New Zealand
Norway
Poland
Portugal
Slovak Republic
Spain
Sweden
Switzerland
Turkey
United Kingdom
United States
Mandatory control rights to workers
32
Work councils mandated by law
Employees appoint some board members
1
0
Impact on corporate governance
33
 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:
shareholders
• industrial relations conflict
over division of surplus
• agency conflict:
workers shirk, underinvest in
firm-specific human capital
workers
owner-manager agency conflict:
manager steals or under-monitors workers
(if he owns a small equity stake)
manager
• conflict if manager owns a large equity stake
• congruence if manager has small equity stake
Managers’ “easy life” and
“natural alliance” with workers
34
 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”)
Evidence on “easy life” and “natural alliance”
35
 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)
Incentive effects of workers’ ownership/control
36
 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)
Incentive effects (2)
37
 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)
Conclusion
38
 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)