Why Strong Labor Laws Can Help Poor Managers Keep Their Jobs
Restructuring decisions often have unexpected results.
ANN ARBOR, Mich.—A recent University of Michigan study reveals that the relative strength of laws protecting labor and investors affects restructuring decisions made by firms showing a sharp deterioration in operating performance.
"Our study demonstrates that investor protection and labor laws cannot be studied in isolation," said E. Han Kim of the Stephen M. Ross School of Business. "They are closely intertwined in their influence on firms' responses to the conflicting interests of different stakeholders."
Contrary to the conventional wisdom that asset restructuring by poorly performing firms is value-enhancing, Kim and doctoral candidate Julian Atanassov found that asset sales in countries with weak investor protection appear to destroy value. Moreover, the frequency of such asset sales is greater when the strength of investor protection is weaker.
"When investor protection is weak, strong labor-union laws appear to encourage poorly performing firms to sell off good assets to pay workers," said Kim, the Fred M. Taylor Professor of Business Administration and professor of finance and international business. "Interestingly, strong collective-relations laws also help poorly performing managers retain their jobs, suggesting possible collusion between management and labor."
Their findings suggest that management exercises restraint in laying off workers and finances the company payroll with the proceeds from value-destroying asset sales, while workers in turn support retention of current management through industrial and/or political actions intended to lobby for government bailouts or reorganization.
"Such collusion is harmful to investors and, hence, it is more prevalent when strong collective-relations laws are combined with poor investor protection," Kim said.
When investor protection is strong, however, poorly performing firms are more likely to undertake large-scale employee layoffs and to force top-management turnover. Firms in strong investor protection countries also are more apt to sell underperforming assets as investor protection becomes stronger, leading to superior subsequent operating performance compared to companies without asset sales.
To determine how labor laws, investor protection and firm-specific variables influence restructuring decisions, Kim and Atanassov studied 9,923 firms with sharply declining performance in 41 developed and emerging economies over the period of 1993 to 2004. They focused on three types of restructuring measures: large-scale employee layoffs, major asset sales and top-management turnover, which previous studies have suggested tend to improve stock prices and operating performance.
"Although these improvements should be good for shareholders, part or all of the gains may arise at the expense of other stakeholders," Kim said. "If the sacrificing stakeholders are workers and management, they are likely to resist the pressure from investors to restructure. Therefore, from a financier's perspective, shareholders' ability to force value-enhancing actions on poorly performing firms may be viewed as an ex-post measure of the quality of corporate governance."
Kim and Atanassov report that firm-specific variables may affect investors' abilities to force restructuring. For example, although ownership concentration tends to increase the likelihood of employee layoffs, management turnover and asset sales, this is true only when top managers are not large shareholders. When top managers hold substantial ownership stakes, there are fewer management dismissals and asset sales, demonstrating managers' reluctance to dismiss themselves or to reduce private benefits associated with a larger asset base.
Financial leverage, which strengthens financiers' bargaining position vis-à-vis labor, also is positively related to the likelihood of all three types of corporate restructuring. However, when leverage interacts with legal variables, the results often are intensified. For example, in cases where investor protection is strong, leverage shows more bite in forcing layoffs and management turnover. Leverage also weakens the preventive effect of strong union laws on large-scale layoffs.
The researchers acknowledge that other laws governing antitrust, consumer protection, environmental impact and taxes also may have an important influence on firm behavior during distress or, more broadly, in shaping corporate governance. In addition, political systems, cultural norms and public/private institutions often interact with laws and regulations to impact governance.
"Perhaps the biggest challenge facing corporate-governance researchers is to understand the interplay among these various factors and to prescribe appropriate policies for countries and companies that are subject to different environments," Kim said.
Written by Claudia Capos
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