Labor Unions, Operating Flexibility, and the Cost of Equity

Abstract

We study whether the constraints on firms’ operations imposed by labor unions affect firms’ costs of equity. The cost of equity is significantly higher for firms in more unionized industries. This effect holds after controlling for several industry and firm characteristics, is robust to endogeneity concerns, and is not driven by omitted variables. Moreover, the unionization premium is stronger when unions face a more favorable bargaining environment and is highly countercyclical. Unionization is also positively related to various measures of operating leverage. Our findings suggest that labor unions increase firms’ costs of equity by decreasing firms’ operating flexibility.

Do Labor Unions Affect Stock Price Crash Risk?

“…Higher labor adjustment costs reduces operating flexibility, hence increases the cost of equity. Consistent with this argument, Chen et al (2011) show that firms from highly unionized industries are penalized by a higher cost of equity.…”

“…Consistent with this point of view, Chen, Kacperczyk, and Ortiz-Molina (2012) show that strong labor union is associated with a lower cost of debt. Furthermore, Chen, Kacperczyk, and Ortiz-Molina, (2011) examine the impact of labor union on the cost of equity. Strong labor protection is associated with higher labor adjustment costs (e.g., Serfling, 2013).…”

Trade Liberalization, Import Penetration and Unionization: The U.S. Experience

“…When we apply lagged values of unionization as an instrument to the current unionization level to obtain exogenous variation in unionization, we find that the economic impact of import penetration on the future unionization rate is −1.88 and statistically significant. 8 In the third and fourth column of Table 2, we find that the impact of import penetration originating from other-wage countries (OWPEN) on unionization rate change is one-third that of low-wage countries, suggesting that imports from low-wage countries have distinct effects. In the last two columns of Table 2, we replicate the main specification using penetrations measures based on imports originating from India and China only.…”

“…Mishel [10] shows that union wage gains are greatest where pricing power enhances employers' ability to pay and where unions achieve high coverage, practice centralize bargaining, and avoid union fragmentation. Chen, Kacperczyk and Ortiz-Molina [8] contend that unions, especially the powerful ones, substantially reduce operating flexibility because they make labor wages more sticky and layoffs more costly. The channel that this may work through may take various forms.…”

“…Chen, Kacperczyk and Ortiz-Molina [8] show that operating leverage, measured by the elasticity of a firm's labor costs with respect to its sales, is negatively correlated with the unionization level of a firm's industry. In addition, Bernard, Jensen and Schott [7] note that because of the high relative wages in U.S., "[i]t is virtually impossible for the U.S. to survive head-to-head competition with the world's most labor-abundant countries in labor-intensive industries," as predicted by standard trade models.…”