Labor and Corporate Governance: International Evidence from Restructuring Decisions

My paper, co-authored with Julian Atanassov of the University of Oregon, was recently accepted for publication in the Journal of Finance. This paper investigates how labor and investors’ relative influence and firm level variables interact to affect corporate governance. A key conclusion is that weak investor protection combined with strong union laws are conducive to worker-management collusion harmful to investors.

Specifically, we analyze restructuring decisions when firms suffer a sudden, sharp deterioration in operating performance. We proxy for stakeholders’ relative influence at the country level by the strength of legal protection of investors and labor. We consider three types of restructuring measures: large scale employee layoffs, top management turnover, and major asset sales. Our sample consists of 9,923 firms (10,947 firm-years) at the onset of sharply declining operating performance in 41 developed and emerging economies over the period 1993 to 2004.

We find that poorly performing firms in stronger investor protection countries are more likely to undertake large-scale worker layoffs and replace top management than those in weaker investor protection countries. These restructuring actions are followed by superior operating performance in all legal environments. Major asset sales are different, however. We observe more asset sales when investor protection is either very strong or very weak. Asset sales in strong investor protection countries are followed by superior operating performance, whereas asset sales in weak investor protection countries are followed by inferior subsequent operating performance.

The likelihood of value-reducing asset sales increases as collective bargaining and labor relations laws grant more power to labor unions, suggesting that these asset sales are countenanced by workers. In addition, underperforming top managers in low investor protection countries are more likely to retain their jobs as union power increases. These results point toward management-worker alliances motivated by a mutual desire to retain jobs. For such an alliance to work, management needs funds to minimize layoffs and wage cuts. Lacking other means to raise the necessary funds, poorly performing firms sell assets to forestall layoffs even when doing so hurts subsequent operating performance. Indeed, asset sales in weak investor protection countries do not lead to layoffs, whereas in strong investor protection countries asset sales predict layoffs.

We also find that strong union laws are less effective in preventing layoffs when financial leverage is high, indicating that financial leverage is an effective instrument with which investors counter the power of workers.

Overall, our results highlight the importance of interaction among management, labor, and investors in shaping corporate governance.

The full paper is available for download here.