How Unionization Affects IPO Pricing

In 2000, Overnite Transportation Co. halted its IPO because of a highly disruptive 10-month strike by the Teamsters’ Union. Teamster officials said they had achieved some gains through the strike, noting that Overnite had increased its employees’ hourly wages by $5.25, to $19, and improved pensions and health coverage. In its S-1 prospectus, though, Overnite indicated that the strike had not achieved any other concessions. Nonetheless, the company had to delay its IPO until October 31, 2003. The company sold 25 million shares at $19 each and managed to raise $475 million. This amount probably could have been higher if the strike had not damaged the company’s reputation and discouraged potential investors. In fact, Overnite admitted that the strike had significantly limited growth opportunities by hindering operating efficiency and generating customer concerns about labor strife and its possible impact on service.

Although relevant theory and the business press suggest that organized labor should influence the overall IPO process, it is surprising that very limited academic attention has been directed at the impact that labor has on IPO valuation. Our new study, Unionization and IPO Underpricing, aims to close this gap in the literature by bringing to the fore the role of organized labor as an important element of uncertainty, information asymmetry, and agency costs, which can affect IPO investor interest and returns.

Prior literature has documented the impact of labor unionization on core economic matters, and has highlighted agency costs that can result from the conflicting aims of labor and corporate principals and agents. Labor unions are associated with an adverse effect on corporate performance, because they can make managers more risk-averse and thereby constrain decision-making, delay investments, and slow technological innovation. Additionally, managers of unionized firms often try to shelter corporate income from unions and mitigate the rent-seeking capabilities of unions by adopting income–decreasing accounting methods, lowering cash balances, smoothing earnings, and increasing or maintaining high levels of information asymmetry. Further, prior evidence demonstrates that successful union organizing reduces equity values, and venture capital-backed IPOs of unionized companies are less profitable.

Labor unions act as agents for their members, advancing their claims for better wages, hours, and working conditions through collective bargaining, industrial action, and activism. These efforts are often costly for companies, and divert the time and attention of management from normal operations. Even when managers focus on maintaining a productive relationship with employees, work stoppages, strikes, or other types of conflicts can occur, creating a material adverse effect on the business.

Determining the value of a firm going public is difficult under the best circumstances and the greater information asymmetry, agency costs, and uncertainty associated with unions can complicate matters further. The presence of a union can also increase operating inflexibility and the cost of capital, leading to lower valuations and reduced demand for IPO of unionized issuers.

Our findings reveal that IPOs of unionized firms are underpriced 10.91 percent less than are IPOs of non-union companies. Considering the association between underpricing and retail demand, we argue that this negative relationship reflects modest investor demand. This effect is more pronounced for firms headquartered in states without right-to-work laws that undercut unions.

To identify the cause of the link between unions and IPO underpricing, we examine the periods before and after IPOs and find that, although underwriters commence the price-discovery process from a high starting point, both modest investor demand and the investors’ inclination towards price-protection trigger negative price revisions and cause the offer price to fall below the initial price set by the firm. When we track the trading of unionized companies’ shares issued in an IPO for up to a year after the IPO, we report significantly lower aftermarket volatility (40 percent less) than for IPO shares of non-unionized companies, indicating, lower demand and investor doubt consensus about the prospects of unionized issuers. Extending the examination period up to three years following the IPO date, we find a negative and significant impact of unionization on firm performance and survival confirming investors’ doubts.

Our results suggest that unionization constitutes a significant cost for the issuing firm and that a company’s unionization status represents an important determinant of IPO valuation. Investors consider management independence an important factor in creating growth and shareholder value. Our results further demonstrate that firms with an organized labor force face an 89.8 percent higher risk of failure, indicating a lack of confidence in the markets.

Our study contributes to the existing literature on several fronts. First, we increase understanding of the roles of stakeholders in IPO pricing by documenting the significant reluctance of investors to participate when they consider the risks of unionized companies. Second, we show that the presence of organized labor translates into significant costs for IPOs. Third, we demonstrate evidence related to price discovery process, as we report that the share offer price of unionized firms is significantly suppressed downward when compared to the initial price set by firms.

This post comes to us from Antonios Chantziaras, a research fellow at the El Shaarani Centre for Ethical Finance, Accountability and Governance of Durham University Business School; Dimitrios Gounopoulos, a professor of accounting and finance at the School of Management of the University of Bath; and Stergios Leventis, an associate professor in accounting and dean of the School of Economics, Business Administration and Legal Studies at International Hellenic University. The post is based on their recent paper, “Unionization and IPO Underpricing,” available here.