Labor is an important corporate stakeholder and crucial to a company’s wealth and long-term productivity. Yet the investment of human capital in a corporation is not diversified and depends on the company’s profitability. If the corporation collapses and layoffs follow, employees not only suffer from a loss of their investment and future income but must also find new jobs. While numerous studies have examined how employees try to influence firms’ decisions, there is limited direct evidence on whether labor has a voice in corporate governance.
In a new study, we examine whether labor plays a governance role in curbing unethical management behavior – opportunistic insider trading. We also explore several economic mechanisms through which the labor force can influence opportunistic insider behavior and assess the economic consequences of labor’s disciplining effect.
We employ the proportion of organized labor in a firm (i.e., the number of unionized employees divided by the total number of employees) as a proxy for labor voice. Such a measure is well suited for our research as labor unions are coordinated individual employees that can exert a substantial influence on corporate decisions and management behavior. For robustness, we also use employee ownership as an alternative labor voice proxy, although the number of firms with employee ownership is significantly smaller. We focus on two alternative opportunistic insider trading measures in an attempt to tease out implicitly illegal insider trading. The first is the number of opportunistic insider trades, computed by stripping away routine trades from the overall insider trades. Routine trades are those based on predictable patterns of past trading and convey no material information about a firm’s future performance. The second measure captures the risk-adjusted profits that insiders can earn from company stock purchases, as well as the losses insiders can avoid through sales.
Our sample builds on the intersection of two primary data sources: the firm-level unionization information from companies’ 10-K filings available through SEC EDGAR and U.S. insider trading data from Thomson Reuters’ insiders filing database. Our final sample consists of 33,515 firm-year observations from 5,054 unique firms for the 1996-2017 period. We find that labor voice is negatively related to both opportunistic insider trading frequency and profitability even after controlling for various firm-specific variables that prior studies have found to be good predictors of insider trading activity. Opportunistic insider trading is about 7.0 percent to 7.9 percent lower in unionized firms than in nonunionized firms. Also, the average annualized abnormal stock return of insider trades in unionized firms is about 9.5 percent smaller. Our findings suggest that organized labor plays an effective role in disciplining the opportunistic insider trading behavior.
To test causation, we use a regression discontinuity design that relies on exogenous variation generated by voting outcomes of firms’ new unionization proposals that pass or fail by a small margin of votes (around the actual threshold hurdle). The passage of these proposals is similar to a random assignment of unionization status to firms and hence should not influence subsequent opportunistic insiders’ trading. Therefore, such proposals can be used to estimate the causal effect of unionization status on insider opportunism. Our results show that winning a union election by a narrow margin is followed by a reduction in both opportunistic insider trades and trading gains.
In another test, we use the variation in whether states have adopted Right-To-Work (RTW) laws as a quasi-natural experiment to examine the power of collective labor voice on opportunistic insider trading. RTW laws offer workers a choice to opt out of joining or paying dues to unions, and such legislation would, therefore, weaken organized workers’ voice. Thus, we expect labor voice to be weaker in states with RTW laws. Our analysis documents more opportunistic insider trading activity after RTW law adoption, suggesting a weakening governance effect of labor voice.
We explore three economic mechanisms through which organized labor can restrain opportunistic insider trading. The first is through a firm’s environmental and social initiatives. Socially responsible firms work to ensure that their employees have fundamental labor rights, to promote management-labor dialogue, to develop environmental, social, and governance (ESG) initiatives, and to discuss employee working conditions and other issues. Employees, in turn, embrace their firm’s commitment to ESG values that align with their own. Our results show that organized labor plays a more active governance role in socially responsible firms.
Another mechanism stems from unions’ role as shareholders through union pension funds. Union pension funds are considered the most vocal shareholder class. Prior research shows that they cast proxy votes that pursue workers’ interests, challenging the governance of companies. Voting campaigns initiated by union pension funds may receive support from other socially conscious shareholders whose goals are not to maximize profits but to improve the socially responsible practices of the company. Our test yields consistent evidence that active union pension funds pose a powerful threat to unethical management behavior – opportunistic insider trading.
The third mechanism is the disciplining effect of unions’ media networks and political support. Prior literature portrays unions as more vocal than analysts, auditors, or other shareholders about corporate governance, and they express their opinions through union websites, media, and politicians. The external mechanism, therefore, builds upon unions’ ability to mobilize external resources to expose management misconduct. The negative publicity jeopardizes management’s reputation and raises its litigation risk. Besides, there is an historical alliance between the labor movement and the Democratic Party. The party, in general, puts more emphasis on government oversight of issues relating to corporate social responsibilities, including the environment, anti-discrimination laws and their enforcement, and employee welfare. It is plausible that unionized labor receives more political support when the Democratic Party rather than the Republican Party is in power. Our results indicate that both opportunistic insider trading activity and profits are significantly lower in unionized firms that operate where a Dow Jones news office is located and when the U.S. president is a Democrat.
Finally, we investigate the economic implications of the disciplining role of labor in restricting management opportunism and improving corporate governance. Firms generally oppose unions, believing that they are counter-productive and costly, particularly for their shareholders. In contrast, our study finds that organized labor has a bright side — its restraint on opportunistic insider trading helps reduce managerial power to extract rents and, in turn, improves firm productivity and performance. Also, there is a remarkable decline in predictable returns from insider trades in unionized firms. This finding conveys an important signal to investors that attempt to exploit the information contained in insider trades to make abnormal returns — these trades tend to be less informative when employees can effectively monitor management.
This post comes to us from Professor Lilian K. Ng at York University’s Schulich School of Business; Man Pham, a PhD candidate at the University of Western Australia; and Professor Jing Yu at the University of Western Australia. It is based on their recent article, “Labor Voice in Corporate Governance: Evidence from Opportunistic Insider Trading,” available here.