Do Managers Give Hometown Labor an Edge?

Scott Yonker is Assistant Professor & Lynn Calpeter Faculty Fellow in Finance at the Dyson School of Applied Economics and Management at Cornell University. This post is based on his recent article, recently published in the Review of Financial Studies.

Anyone who has been in the workforce has likely either experienced or known someone who has felt the effects of employee favoritism. Whether it is getting passed over for a promotion because your competition was the CEO’s college buddy or being spared from downsizing because your supervisor knew that you, unlike your co-workers, had mouths to feed at home. The pervasive view in economics is that favoritism leads to inefficient human resource allocation and ultimately destroys firm value. However, there is very little direct evidence that top managers (CEOs) at U.S. firms systematically favor some employees over others. In my article, Do Managers Give Hometown Labor an Edge?, which was recently published in the Review of Financial Studies, I test for evidence of employee favoritism by CEOs of large U.S. firms.

There are two main challenges with testing for employee favoritism in broad corporate employment policies. The first is identifying a set of employees that top managers might systematically favor over others. The second is actually identifying an effect. Economists question if favoritism biases of top managers can expressed in a corporate setting. Therefore, even if corporate managers prefer to favor certain workers over others, those monitoring them would likely prohibit them from doing so.

To address the first challenge, I lean on the well-documented environmental psychology concepts of place attachment and place identity. Research on place attachment has shown that people form psychological bonds to locations “where they prefer to remain and where they feel comfortable and safe” (Hernandez et al. 2007, p.311) and that these bonds induce action. One place where people form particularly strong bonds is in the vicinity of their childhood homes. People are more likely to invest their time and money in their places of attachment. Therefore, I hypothesize that corporate managers, on average, will make corporate employment decisions that favor workers located near their childhood homes over others.

The second challenge is ultimately an empirical one. Finding positive evidence that CEO birthplaces influence their labor allocation decisions suggests that the personal characteristics of a few powerful individuals (CEOs of large firms) can have implications for resource allocations in the broader economy.

To conduct my tests, I collect birthplace information on CEOs of S&P 1,500 firms and combine these data with the Bureau of the Census’ Longitudinal Business Database (LBD, hereafter), which includes employment and wage information for all units (physical locations that can include plants, offices, or retail space) owned by each firm. I then calculate distances between units and CEO birthplaces and test whether these distances influence how firms reallocate labor resources across units following times of industry distress. The main idea of the test is that industry distress induces managers to make decisions about how to weather the storm, if they must make cuts, then they will need to decide in which units to do so. Variation in distances of units from CEO birthplaces allows me to test whether CEOs systematically favor hometown units over others. Of course there are many factors that should influence these resource allocation decisions, such as how important is a particular unit to the firm. I control for these by including in the analysis unit-level measures of size, distance to firm headquarters, and average human capital.

The results show that following periods of industry distress, units located near CEOs’ hometowns experience fewer employment and pay reductions, and are less likely to be divested relative to other units within the same firm. Units located closer to CEO birthplaces experience 4.1% greater employment growth and 2.4% greater wage growth compared to similar units. Since employment and wages fall by 3.0% at the average firm unit following industry distress, these findings suggest that hometown units are largely spared. Moreover, these differences have seemingly permanent effects, the wage differences last at least three years, while employment differences revert about three years after industry downturns. With regard to divestitures, units that are more distant from CEO birthplaces are about 6% more likely to be divested.

Of course, without evaluating the subsequent performance of these actions it is difficult to conclude that this bias toward hometown workers is the result of favoritism. Researchers have shown in many contexts that local knowledge is valuable, so it could be that CEOs actually have better or more precise information about their hometown establishments. Unfortunately, performance metrics are not available at the unit level in the LBD, making it impossible to test directly whether favoritism leads to an inefficient allocation of resources. Instead, I conduct indirect tests based on the notion that good governance should prevent managers from engaging in suboptimal behavior. When splitting the sample between firms that have strong and weak corporate governance mechanisms in place, I find that the biased employment policies are only found among weakly governed firms. This provides indirect evidence that favoritism and not information drives U.S. CEOs to treat their hometown workers better.

There are two main takeaways from this research. First, CEOs play favorites in their corporate employment decisions. Second, the biases and idiosyncratic characteristics of powerful business leaders can have large economic effects on workers. The seemingly insignificant characteristic of CEO birthplace can lead to large differences in employment, wage growth, and even plant survival.

The complete article is available here.

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