Labor Unions and Forms of Corporate Liquidity

• Published date: 01 September 2015
• Date: 01 September 2015
• DOI: http://doi.org/10.1111/jbfa.12122

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 42(7) & (8), 1007–1039, September/October 2015, 0306-686X

doi: 10.1111/jbfa.12122

Labor Unions and Forms of Corporate

Liquidity

ZHENXU TONG∗

Abstract: We examine how the presence of labor unions affects a firm’s choice of corporate

liquidity between bank lines of credit and corporate cash holdings. We find that firms in

industries with higher unionization rates hold a higher fraction of corporate liquidity in the

form of bank lines of credit. We divide the firms into sub-groups and find that this positive

relationship holds for firms that are not in a state with right-to-work legislation and for firms

that are financially constrained. Our findings are consistent with the hypothesis that a firm

chooses the forms of corporate liquidity to take advantage of the bargaining benefits associated

with bank lines of credit.

Keywords: bank lines of credit, corporate cash holdings, labor unions

1. INTRODUCTION

Bank lines of credit and corporate cash holdings are two main forms of corporate

liquidity. Bates et al. (2009) find that the average cash-to-assets ratio for US firms was

23.2% in 2006. Sufi (2009) finds that bank lines of credit have an average magnitude

of 16% of assets in a sample of US firms. In this paper, we examine how the presence of

labor unions affects a firm’s choice of corporate liquidity between bank lines of credit

and corporate cash holdings.

Corporate cash holdings are a firm’s internal resources, while bank lines of credit

are an external source of financing. Previous research in the literature (e.g., Baldwin,

1983; and Bronars and Deere, 1991) argues that debt increases a firm’s bargaining

power over labor. Because a firm obtains a certain amount of debt capacity when it

receives bank lines of credit, the firm can increase the amount of debt by drawing

down the lines of credit if it anticipates that bargaining with labor unions will take

place. Moreover, while cash is a form of realized liquidity, the availability of bank lines

of credit is usually subject to a firm’s compliance with covenants (e.g., Sufi, 2009; and

Yun, 2009). A firm can make a more credible case that the risk associated with the

unavailability of bank lines of credit can threaten its competitive viability, a situation

that would be exacerbated by granting additional concessions to the union. Therefore,

∗The author is from the School of Business, University of Exeter, UK. The author would like to thank

Norman Strong (the Editor), an anonymous referee, and seminar participants at the University of Exeter

for their comments and suggestions.

Address for correspondence: Zhenxu Tong, Xfi Centre for Finance and Investment, School of Business,

University of Exeter, Rennes Drive, Exeter EX4 4ST, United Kingdom. Telephone: +44 1392 723155.

e-mail address: z.tong@exeter.ac.uk.

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a firm can use more bank lines of credit as a source of corporate liquidity to gain a

better bargaining position against labor unions.

We hypothesize that a firm holds a higher fraction of corporate liquidity in the

form of bank lines of credit when unionization rates are higher. Moreover, we

develop hypotheses on how right-to-work legislation and financial constraints affect

the relation between unionization rates and forms of corporate liquidity.

In our empirical tests, we use industry unionization rates, defined as the fraction

of workers in an industry who are covered by labor unions in collective bargaining,

as our measure of the bargaining power of labor unions. We use the ratio of bank

lines of credit to the sum of bank lines of credit and corporate cash holdings as our

measure of a firm’s choice of the forms of corporate liquidity. Because endogeneity

can be a potential concern, we use instrumental variables with two-stage least squares

estimation.

We find that firms hold a higher fraction of corporate liquidity in the form of bank

lines of credit in the presence of stronger labor unions. The data show that a one

standard deviation increase in the fraction of workers covered by labor unions leads

to a 14.48% increase in the fraction of corporate liquidity held in the form of unused

lines of credit. This corresponds to an increase in unused lines of credit with a value

of US$37.20 million. Moreover, we find that the level of bank lines of credit increases

with unionization rates.

We divide the firms into sub-groups and find that a positive relation between

unionization rates and the fraction of corporate liquidity held in the form of bank

lines of credit exists in the sub-group of firms that are not in a state with right-to-work

legislation. We conduct the analysis for a sub-sample of firms whose state of operation

is the same as the state of incorporation and find similar results. Moreover, we use

the Heckman two-stage estimation to control for a firm’s self-selection of the state

of incorporation/operation and find similar results. In addition, we examine labor

costs and operating profitability. We find that there is a negative relation (no relation)

between the fraction of corporate liquidity held in the form of bank lines of credit

and labor costs for firms that are not in (are in) a state with right-to-work legislation

and that there is a positive relation (no relation) between the fraction of corporate

liquidity held in the form of bank lines of credit and operating profitability for firms

that are not in (are in) a state with right-to-work legislation.

We also divide the firms into sub-groups and find that a positive relation between

unionization rates and the fraction of corporate liquidity held in the form of bank

lines of credit exists in firms that are financially constrained. We conduct robustness

checks and find similar results when we control for labor intensity and when we use

union membership as an alternative measure of the bargaining power of labor unions.

We conclude that our findings are consistent with the hypothesis that a firm chooses

the forms of corporate liquidity to take advantage of the bargaining benefits associated

with bank lines of credit.

Our study makes two main contributions. First, our research extends the literature

by providing evidence on how labor, as a type of stakeholder, affects a firm’s choice

of corporate liquidity. While the literature reveals various reasons why a firm chooses

corporate liquidity between bank lines of credit and cash holdings,1to our knowledge,

1 Besides a firm’s choice of the forms of corporate liquidity,various determinants of corporate cash holdings

have been examined in the literature. For example, Opler et al. (1999) argue that corporate cash holdings

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no previous research documents the relation between labor and a firm’s choice of

the forms of corporate liquidity. For example, Sufi (2009) shows that high cash flows

are an important determinant of the forms of corporate liquidity because they allow

firms to comply with cash flow-based covenants associated with bank lines of credit.

Yun (2009) finds that firms increase cash relative to lines of credit after a change in

takeover legislation that weakens the threat of takeover. Lins et al. (2010) find that

lines of credit are strongly related to a firm’s need for external financing to fund

future investment opportunities and that cash is primarily held as a general buffer

against future cash flow shortfalls. Campello et al. (2010) show that small, private,

junk-rated, and unprofitable firms have larger credit lines and that firms with high

internal liquidity find lines of credit less valuable. Acharya et al. (2009) examine how a

firm’s exposure to aggregate risk affects its management of liquidity through bank

lines of credit and cash holdings. Tong (2012) finds that diversified firms hold a

higher fraction of corporate liquidity in the form of bank lines of credit due to the

coinsurance effect. Therefore, we extend the literature by disclosing a new dimension

that affects a firm’s choice of the forms of corporate liquidity.

Second, we add to the literature on how strategic considerations that arise in

bargaining between firms and labor unions affect corporate decisions. Specifically,

we provide evidence that the bargaining power of labor unions affects a firm’s

choice between bank lines of credit and cash holdings. Previous research in the

corporate finance literature focuses on the impact of labor unions on leverage (e.g.,

Bronars and Deere, 1991; Hanka, 1998; and Matsa, 2010), earnings management

(e.g., DeAngelo and DeAngelo, 1991; and D’Souza et al., 2001), and the cost of

equity (e.g., Chen et al., 2011). Moreover, Agrawal (2012) finds that labor union

pension funds have preferences that partly reflect union worker interests rather than

equity value maximization alone. A previous study related to our research is Klasa

et al. (2009), who study how the bargaining power of labor unions affects a firm’s

management of corporate cash holdings. Our study differs from Klasa et al. (2009) in

that they only study corporate cash holdings, while we examine a firm’s choice of the

forms of corporate liquidity between bank lines of credit and corporate cash holdings.

The paper is organized as follows. Section 2 develops the hypotheses. Section 3

describes the data and the variables. Section 4 illustrates the methodology. Section 5

presents the results. Section 6 concludes the paper.

2. HYPOTHESIS DEVELOPMENT

Corporate cash holdings are a firm’s internal resources, while bank lines of credit

are an external source of financing. A firm obtains a certain amount of debt capacity

when it receives bank lines of credit. Used lines of credit are recorded as a debt

obligation, while unused lines remain off balance sheet. We analyze the bargaining

benefits associated with bank lines of credit relative to corporate cash holdings from

the perspectives of debt capacity and the possible unavailability of bank lines of credit.

can be explained by the tradeoff theory, the financing hierarchy theory and agency theory. Dittmar et al.

(2003) find that the level of corporate cash holdings is determined by the degree of shareholder protection

in different countries. Tong (2010) finds that firms with higher CEO risk incentives have less cash holdings.

Neamtiu et al. (2014) find that macroeconomic ambiguity is positively associated with cash holdings.

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