Right‐to‐Work Laws and Financial Leverage

• DOI: http://doi.org/10.1111/fima.12065
• Published date: 01 March 2015
• Author: Dalia Marciukaityte
• Date: 01 March 2015

Right-to-Work Laws and Financial

Leverage

Dalia Marciukaityte∗

High leveragecan be used to improve a firm’s bargaining position with unions. I find that this use

of leveragein the United States is concentrated in states without right-to-work (RTW) laws. The use

of high leverage by unionized firms in these states is associated with high market-to-book ratios

and is more likely when shareholder and manager interests are aligned through compensation

contracts. I confirm these findings by examining the adoption of RTW laws in Oklahoma, as well

as presidential and congressional elections. Moreover, I confirm the importance of RTW laws

using cash balances instead of leverage.

The evidence concerning the relationship between leverage and unionization is mixed. While

some studies suggest that unionized firms use higher leverage to increase their bargaining power

with unions (Bronars and Deere, 1991; Klasa, Maxwell, and Ortiz-Molina, 2009; Matsa, 2010),

other studies find no relation between leverage and unionization (Lee and Mas, 2009; Chen,

Kacperczyk, and Ortiz-Molina, 2012). As these studies examine different samples, one possible

explanation for different findings is the varying union power in different studies. Increasing

leverage is costly. It increases a firm’s risk and reduces its financial flexibility. It is possible that

only powerful unions induce firms to increase leverage. Moreover, in some of these studies, the

positive relation between leverage and unionization may be weakened by endogeneity issues.

While unionized firms are likely to prefer higher leverage, unions are likely to prefer firms

with lower leverage. I address these two issues by comparing the relation between leverage and

unionization across the US states with different labor laws.

In the United States, labor laws vary significantly across states. The National Labor Relations

Act of 1935 grants significant power to unions. However, the adoption of right-to-work (RTW)

laws by states eliminates some of the granted privileges, reducing union financial power and

creating a significant variation in this power across the states. In this paper, I examinewhether the

positive relation betweenleverage and unionization is driven by firms in states without RTW laws

where unions have the most power. Moreover, I study whether using higher leverage when facing

powerful unions is beneficial to shareholders. Comparing the effect of unionization on leverage

in states with and without RTW laws allows me to mitigate endogeneity problems arising from

union preference for firms with lower leverage. Unions are likely to prefer low leverage in all the

states.1

∗Dalia Marciukaityte is an Assistant Professor of Financein the Department of Finance, Insurance and Law, College of

Business at Illinois State University in Normal, IL.

I am grateful for the comments and suggestions fromRaghavendra Rau (Editor), the associate editor, a referee,Christa

Bouwman, Gary Koppenhaver,Aslihan G. Korkmaz-Cicek, Richard Miller, Kenneth Roskelley, Christopher Tamm, and

seminar participants at Case WesternReserve University. All errors remain the responsibility of the author.

1It is possible that unions are more successful in unionizing lower leverage firms in states without RTW laws where

unions have more power, weakening the positive relation between unionization and leveragein these states. This would

bias my tests toward a finding of no significant impact of RTW laws on the relation betweenunionization and leverage.

My findings reported in this paper would be conservative estimates of the impact of RTW laws.

Financial Management •Spring 2015 •pages 147 - 175

148 Financial Management rSpring 2015

I examine a sample of firms included in the S&P 1500 index in 1997, excluding financial

firms and utilities. To measure unionization, I use the percentage of unionized employees in a

firm as reported in 10-K statements. The study period is from 1995 to 2012. Matsa’s (2010) study

indicates that firms in unionized industries reduced their leverage after the adoption of RTW laws

during the 1950s and 1960s. During this period, unionization was 26% to 34% (Wachter, 2007).

However, union power has declined significantly since that time, dropping to 10% and lower

for private sector unionization after 1995 (Wachter, 2007). It is unclear whether RTW laws have

the same impact on leverage decisions today. Moreover, Matsa’s (2010) study does not indicate

whether the positive relation between leverage and unionization continues in states that adopt

RTW la ws.

I find that from 1995 to 2012, the positive relation between leverage and unionization exists

only in those states without RTW laws. In these states, book (market) leverage of firms where

the majority of the employees are unionized is 9.32 (13.05) percentage points higher than that

of other firms, controlling for f irm and state characteristics. To control for state characteristics,

thus minimizing endogeneity problems, I use the differences in differences approach, comparing

the effect of RTW lawson unionized and nonunionized firms. As RTW laws affect union power,

their effect should be concentrated among unionized firms. Moreover, I examine both the level

and changes in leverage.

If managers use leverage to protect shareholders from strong unions, these actions should

be more common when shareholder and manager interests are aligned. Accordingly, I find that

unionized firms are more likely to have higher leverage in states without RTWlaws when manager

compensation is more sensitive to firm performance.

Consistent with acting in shareholder interests, I also find that higher leverage for unionized

firms in states without RTW laws is associated with higher market-to-book ratios. I confirm

these results using changes in market-to-book ratios. Overall, these findings are consistent with

the hypothesis that firms successfully use higher leverage to improve their bargaining position

with unions when unions are especially strong due to the absence of RTW laws. All of the above

mentioned relations are found only in the states without RTW laws, suggesting that these laws

have a significant impact on firms.

Oklahoma adopted RTW laws in 2001. Using a sample of firms in Oklahoma and neighboring

states without RTW laws, I examine the changes in leverage following the adoption of RTW

laws. To increase the number of observations, this sample is not limited to S&P 1500 firms.

Consistent with my earlier findings, I demonstrate that Oklahoma firms are more likely to reduce

their leverage after the adoption of Oklahoma’s RTW laws than firms in neighboring states.

To provide further evidence to support my findings that f irms use higher leverage to increase

their bargaining power with strong unions, I use presidential and congressional elections as

natural experiments. A victory by Democrats is associated with an increase in union power. If

higher leverage helps to protect shareholders from powerful unions, the market reaction to a

victory by Democrats should be less negative for unionized firms in states without RTW laws

when their leverage is high. My findings confirm this supposition. The market seems to consider

high leverage firms as better prepared to deal with strong unions. This is consistent with my

earlier findings of a positive relation between leverage and market-to-book ratios for unionized

firms in states without RTW laws. In addition, I find that unionized fir ms in states without RTW

laws increase their leverage following election victories by Democrats. This is expected when

Democrats increase union power and firms use leverage to increase their bargaining power with

strong unions.

If RTW laws have a significant effect on union power, they are likely to affect not only the

decisions of unionized firms regarding leverage, but also the decisions of these firms concer ning