LABOR LAWS AND FIRM PERFORMANCE

• Author: Dalia Marciukaityte
• Date: 01 March 2018
• DOI: http://doi.org/10.1111/jfir.12137
• Published date: 01 March 2018

LABOR LAWS AND FIRM PERFORMANCE

Dalia Marciukaityte

Illinois State University

Abstract

U.S. labor laws impose higher costs on unionized firms in states without right-to-work

(RTW) laws. I find that these firms experience poor stock performance. The difference-

in-differences analysis comparing the effect of RTW laws on unionized and

nonunionized firms shows that unionized firms in states without RTW laws

underperform by about 7 percentage points per year. I find further evidence of

underperformance using alternative methods to estimate abnormal stock performance,

examining a natural experiment, showing expected cross-sectional patterns, and

assessing profitability and the market reaction to earnings announcements.

JEL Classification: G38

I. Introduction

In the United States, labor laws vary across the states. An important difference is caused

by right-to-work (RTW) laws adopted by about half of the states. One common feature of

these laws is the abolishment of the union right to collect fees from nonunionized

employees, reducing the financial strength and bargaining power of unions. I examine the

effect of RTW laws on stock performance of unionized firms.

Most RTW laws were adopted before the mid-1960s, but early studies report that

RTW laws were often ignored, with unions finding ways to circumvent them (e.g.,

Lumsden and Petersen 1975). Accordingly, Bronars and Deere (1990), examining the

effect of union elections on firm value during 1962–1980, find only weak evidence that

RTW laws reduce union bargaining power. Moreover, Abraham and Voos (2000),

examining the market reaction to events related to the adoption of RTW laws in

Louisiana (1976) and Idaho (1985–1986), conclude that RTW laws increase firm value

only by about 2% to 4%. Overall, early evidence suggests that the effect of RTW laws is

small.

However, recent studies provide stronger evidence that RTW laws matter.

Unionized firms in states without RTW laws keep higher leverage, lower cash balances,

lower investment, and lower CEO compensation to improve their bargaining power with

I am grateful for constructive comments and suggestions from Brett Myers (a referee). I also thank James

Brown, Bob Chirinko, Burcu Esmer, Peter Foreman, Mike Grobner, Aslihan G. Korkmaz, and seminar participants

at Illinois State University, 2015 Midwestern Finance Association meetings, 2016 Financial Management

Association meetings, and 2016 Southern Finance Association meetings for their suggestions. All errors remain the

responsibility of the author. This paper benefited from the 2015 Department Chair Faculty Scholar award at Illinois

State University.

The Journal of Financial Research Vol. XLI, No. 1 Pages 5–32 Spring 2018

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© 2018 The Southern Finance Association and the Southwestern Finance Association

unions (Matsa 2010; Marciukaityte 2015, 2017; Huang et al. 2017). These firms have

higher risk and, based on earnings forecasts, higher implied costs of equity (Chen,

Kacperczyk, and Ortiz-Molina 2011). Moreover, the recent adoptions of RTW laws by

Indiana, Michigan, Wisconsin, West Virginia, Kentucky, and Missouri, happening

despite strong union resistance, suggest that both unions and legislators in these states

believe that these laws matter.

1

As firms in states with and without RTW laws often are in the same industries,

unionized firms in states without RTW laws have to compete with firms that have lower

union costs. Moreover, allowing unions to collect fees from nonunionized employees is

not common in other countries. Thus, unionized U.S. firms from states without RTW

laws may also have a disadvantage when competing with some foreign firms. As

industrialization of states with RTW laws continues, more states adopt RTW laws, and

restrictions to foreign trade decline, the disadvantage of higher union costs may become

more important for unionized firms in states without RTW laws. When not all

competitors experience equally high unionization costs, firms incurring higher costs

cannot transfer all of these costs to their customers. If these firms try to charge higher

prices or offer lower quality products, their customers shift their business to firms with

lower labor costs. When firms cannot transfer their higher costs to other parties, their

shareholders, the residual claimants of the firms, earn lower returns.

I study stock performance of S&P 1500 firms from 1996 to 2015. Business

location and firm-level unionization (the percentage of unionized employees in a firm)

are from 10-K statements. I find that stock returns of unionized firms (firms with

unionization greater than 40%) in states without RTW laws are low. The average

annualized return of these firms is about 4 percentage points lower than that of unionized

firms in states with RTW laws and about 8 percentage points lower than that of

nonunionized firms in states without RTW laws. The underperformance is even stronger

when I examine returns adjusted for size and book-to-market, or size, book-to-market,

and prior return.

To make sure that my findings are driven by labor laws, I employ several

additional tests. First, I use difference-in-differences tests, comparing the effect of RTW

laws on the stock performance of unionized and nonunionized firms. These tests control

for differences between states with and without RTW laws as well as for differences

between unionized and nonunionized firms. Similar to earlier tests, I find that unionized

firms in states without RTW laws underperform other firms.

In further tests, I use a continuous measure of unionization (the percentage of

unionized employees in a firm) and control for size, book-to-market, time, industry, and

state. With raw and adjusted returns, I find significant underperformance of unionized

1

Shikha Dalmia, “The Next Battleground in the Labor Wars,”Wall Street Journal, Opinion (September 30,

2012); Stephen Moore, “Michigan Workers Set Free,”Wall Street Journal, Political Diary (April 1, 2013); Paul

Moreno, “How ‘Right to Work’Became Politically Possible,”Wall Street Journal, Opinion/Commentary

(March 15, 2015); Akash Chougule, “A Union Card Shouldn’t Be an Heirloom,”Wall Street Journal, Opinion/

Comentary (March 17, 2016); “Kentucky Goes Right to Work,”Wall Street Journal, Opinion/Review & Outlook

(January 10, 2017); Chris Maher, “Missouri Becomes 28th Right-to-Work State,”Wall Street Journal, U.S.

(February 6, 2017).

6 The Journal of Financial Research