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Owners, managers, and workers:An empirical study of the link between corporate governance and employment policies of firms

Alexander Muravyev (IZA, Bonn) Irina Berezinets (GSOM, St. Petersburg) Yulia Ilina (GSOM, St. Petersburg)

Graduate School of Management, St. Petersburg State UniversityApril 2010

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This project is supported by the Moscow Public Scientific Foundation (MPSF), sponsored by the United States Agency for International Development (USAID). The opinions expressed in this presentation are the authors' opinions and may

differ from the opinions of USAID and/or MPSF.

Owners, managers, and workers: an empirical study of the link between corporate governance and employment policies of firms

by Alexander Muravyev, Irina Berezinets, and Yulia Ilina

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MotivationPagano and Volpin (2008) on the division of economics into sub-

disciplines:“A few years ago, the typical financial economist would have recoiled at the idea that finance may have something to do with labor relations or trade unions, and the typical labor economist would have dismissed as bizarre that shareholder protection or corporate governance might be relevant for labor economics.”

But “… firms need financiers and managers as well as workers, and it would be surprising if the relationships between any two of these parties were not to affect the third one as well, and in turn be affected by its behavior.”

The literature is scarce. A handful of studies link corporate governance and employment relations in firms using the agency perspective (managers as agents of shareholders).

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Existing literature (hypotheses)I. Managers may extract certain private benefits from paying workers

more and building more friendly labor relations in general. Managers’ non-pecuniary private benefits may include “the

attractiveness of the secretarial staff, the level of employee discipline, …, personal relations (‘love’, ‘respect’, etc.) with employees” (Jensen and Meckling 1976 JFE).

Higher pay can also reduce the CEO’s effort in wage bargaining with trade unions. While the full cost of wage bargaining is borne by the CEO, she only receives a small fraction of the gains from a lower total wage.

II. Higher employee compensation can protect the CEO’s job or private benefits of control (those not directly related to labor relations) against raiders.

Workers and trade unions can be turned into an anti-takeover mechanism: the inability to renege worker wages transforms the firm into an unattractive takeover target (Pagano and Volpin, 2005 JF).

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Empirical evidence Bertrand and Mullainathan (1999 RAND, 2003 JPE): there is a

significantly larger increase in the wage bill for US firms incorporated in states that passed anti-takeover laws in the 1980s. This may be interpreted as evidence that poorly governed CEOs want to “enjoy the quiet life” through lower effort wage bargaining.

Landier, Nair, and Wulf (2007 RFS): firms in the US are less likely to lay off workers located geographically closer to corporate headquarters. Part of this behavior seems to reflect private benefits that come from interacting with workers and communities close to corporate headquarters.

Pagano and Volpin (2005 JF): managers collude with workers by paying them above market wages to thwart hostile takeover attempts.

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Empirical evidence (contd.) Atanassov and Kim (2009 JF) document the importance of interaction

among management, labor, and investors in shaping corporate governance using cross-country data. They find that strong union laws protect not only workers but also underperforming managers. Weak investor protection combined with strong union laws are conducive to worker–management alliances, wherein poorly performing firms sell assets to prevent large-scale layoffs, garnering worker support to retain management.

Cronqvist, Heyman, Nilson, Svaleryd, and Vlachos (2009 JF) use data from Sweden to find that CEOs with more control pay their workers more, but financial incentives through cash flow rights ownership mitigate such behavior. Entrenched CEOs pay more to employees closer to them in the corporate hierarchy, geographically close to the headquarters, and associated with conflict-inclined unions. Interpretation: entrenched CEOs pay more to enjoy private benefits such as lower effort wage bargaining and improved social relations with employees.

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This study This paper aims to relate a firm’s employment policies (wages,

arrears) to the scale of the private benefits of control, PBC (~ the severity of corporate governance problems in the firm: “stealing” + “shirking”) in a more direct way than the previous studies.

Most of the available evidence is indirect: For example, Cronqvist et al. (2009) relate workers’ wages to CEOs’ ownership of voting and cash flow rights in dual class stock firms and find positive and negative associations, respectively.

The major challenge in the project is the estimation of PBC, which are intrinsically unobservable.

We do not claim causality in this study: the focus is on the correlation between corporate governance and employment policies of firms. Essentially, the sign interpretation of the results.

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Private benefits of control PBC are a centerpiece of the recent literature on corporate finance

(Dyck and Zingales 2004 JF). However, little progress in measuring PBC: by their very nature, private benefits of control are difficult to observe and even more difficult to quantify. If PBC could be evaluated they would immediately loose their “privacy” and minority shareholders could bring in a lawsuit against the corporation or the controlling owner.

Two ways to obtain a proxy for PBC (always non-random samples!): 1. The value vote approach, based on comparing prices of voting and non-

voting stocks of same companies. The difference in prices, the so-called voting premium, reflects the price a potential bidder would be willing to pay to atomistic holders of voting stock in order to establish control over the company and thus is correlated with the size of control benefits (Rydqvist, 1997).

2. The controlling block sales approach: PBC are the difference between the price of shares in transactions involving control block change and the share price in the stock market after the announcement of the control block sale (Barclay and Holderness, 1989).

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Empirical strategy Obtain a sample of dual-class stock firms traded in the market; Compute a proxy for PBC; Relate this proxy to the employment policies of firms.

We analyze data from Russia, so far, from 1997-2004. This is an interesting case per se, but the focus on Russia also provides two important advantages from a pure research perspective: Extremely large variation, both cross-sectional and over time, in key labor

market and corporate governance variables. Large number of exogenously created dual-class stock companies (due to

privatization regulations of the early 1990s). About 150 dual-class stock companies are traded in 2000.

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Institutional background: the labor market Huge economic shock of the 1990s with GDP falling by about 45%. Only modest effect on the level of employment and on the

unemployment rate (never exceeded 14%). Labor market adjustment comes primarily via wages (facilitated by

high inflation rates) and non-standard mechanisms, such as wage arrears.

While there are various interpretations of this adjustment path (the Russian labor market a is competitive and flexible or even “a neoclassical dream” (Layard and Richter, 1994); or, alternatively, very rigid due to high separation and hiring costs, etc.), the key is the remarkable variation of the labor market variables, both over time and across space.

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Variation in key labor market vars.Gross monthly wages, RUR

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

year

Rub

les

ILO unemployment rate, %

0

2

4

6

8

10

12

14

16

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

year

%

Change in real wages, year to year%

-30

-20

-10

0

10

20

30

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

year

%

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Variation in key labor market vars. (contd.)Arrears volume, bln. RUR

0

10

20

30

40

50

60

70

80

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

year

bln.

RU

R

No. of firms having wage arrears, thnds

0

20

40

60

80

100

120

140

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

year

No.

firm

s, th

ousa

nds

Number of workers experiencing wage arrears, mln

0

5

10

15

20

25

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

year

mln

. peo

ple

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Variation in key labor market vars. (contd.)ILO unemployment rate by region in 2000, %

0

5

10

15

20

25

30

35

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85

regions

%

Nominal wages by region in 2000, RUR

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85

region

RU

R

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Institutional background: corporate governance Severe governance failures with many instances of outright

expropriation of shareholders, especially in the 1990s. Shleifer and Vishny (1997): in the mid-1990s, Russian managers

could appropriate as much as 99% of firms’ profits. Goetzmann et al. (2003): Russia is a “Wild West” of corporate

control. These governance risks are reflected in the unusually high – by

international comparisons - values of the voting right, which is one of the measure of PBC (up to 200% premium on voting shares).

Substantial improvements in the corporate governance in the early 2000s.

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Variation in the voting premiumPremium on common shares: SNGS

0%

50%

100%

150%

200%

250%

300%

350%

Premium on common shares: RTKM

0%

50%

100%

150%

200%

250%

300%

350%

2/9/19

96

7/4/19

97

10/11

/1997

19/06

/1998

22/01

/1999

27/08

/1999

3/4/20

00

3/11/2

000

15/06

/2001

18/01

/2002

26/08

/2002

2/4/20

03

4/11/2

003

16/06

/2004

24/01

/2005

29/08

/2005

Premium on common shares: EESR

0%

50%

100%

150%

200%

250%

300%

350%

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Modelling strategy

Two separate equations:

the “finance” equation (CG conflict = size of private benefits of control) the “labor” equation describing wage policies of firms.

Log(Wageit)= + Zit +it +φt + uit (2)

VPit = α + Xit +it +ψt + vit (3) Where it and it are “managerial actions” wrt workers and shareholders. If we could observe and measure it and it, we would be done.

However, these quantities are unobserved. Therefore, as we have to omit these variables when estimating (2) and

(3), the “managerial actions” show up in the residuals. We thus take the residuals from the two equations (they are proxies for

managerial actions!) and check how they are related! We regress residuals from (2) on residuals from (3) and also check if the

relationship is influenced by control structure in the firm. Interactions.

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The finance equation

Derived from the voting premium model by Zingales (1994, 1995):

VP = Ф (B/y) (1/) , where VP= Price(voting share)/Price(non-voting share) - 1, B is the size of the private benefits of control, y – the value of cash flow rights, – the fraction of voting shares outstanding, and Ф is the probability of a control contest.In logs, (1) is transformed into an additive form. Unobserved B/y becomes a part of the error term. The residual can be regarded as a proxy for the private benefits of control.

Additional controls: liquidity, industry dummies + a bunch of differential characteristics of Russian preferred shares (dividend rules, enfranchisement, ADR issue, etc.) + time dummies.

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The labor equation(s)

Relates wages (wage growth, non-wage payments, wage arrears as a

fraction of payroll) on a set of firm-specific variables, including: Industry dummies Regional dummies Time dummies Capital intensity Firm performance (labor productivity, profitability) Firm size Local labor market characteristics (unemployment rate, monopsony

measure, average wages in a region). The monopsony measure is constructed by dividing the number of

workers in the form to the population of the town the firm (its headquarters) is located.

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Data

Stock market data on all dual-class stock companies traded in the

Russian Stock Exchange in 1997-2004 (www.rts.ru), over 200 firms. The companies’ employment and financial data, from their annual

financial reports from 1996-2004 (Alba, Gnosis, Skrin databases). Extra data characterizing local labor markets (unemployment rates,

wages, etc.).

Excluded: a dozen of companies with non-voting shares convertible into voting shares (not good for measuring PBC).

About 600 observations in total. Firm-level data. 1 to 5 percent of outliers are winsorized or deleted (the results are not

much affected by the exact cut-off). Wages, assets, etc. are CPI deflated.

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Data

Distribution of observations by industry

Power utilitiesOil&gasMetallurgyChemicalMachine buildingLight industryTelecoms

Distribution of observations by federal districts

All FederalCentral North-WesternSouthernVolgaUralsSiberianFar Eastern

Distribution of observations by years

year 1997year 1998year 1999year 2000year 2001year 2002year 2003year 2004

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Data

Voting premium

0.0

0.5

1.0

1.5

2.0

2.5

1997 1998 1999 2000 2001 2002 2003 2004

year

votin

g pr

emiu

m

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Data

Annual wages per worker (thousand 2000 RUR)

0

10

20

30

40

50

60

70

80

90

1997 1998 1999 2000 2001 2002 2003 2004

year

wag

es

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Results: “finance” regressions A

Ln(VP) B

Ln(VP) C

Ln(VP) D

Ln(VP) Shapley 0.985*** Control -0.489*** Downer -0.007*** Cont_sh -0.475*** pi_inverted 0.014 0.209 -0.008 0.007 LiquidityCommon 0.898*** 0.880*** 0.912*** 0.904*** LiquidityPreferred -0.939*** -0.894*** -0.899*** -0.881*** Veto_power 0.020 0.024 0.029 0.046 Ddividend -3.624*** -3.771*** -3.651*** -3.847*** Dividend10 -0.217 -0.217 -0.234* -0.272* ADR 0.035 0.010 0.021 0.016 Vote 0.107 0.100 0.108 0.104 Lower_bound 0.522** 0.474* 0.456* 0.526** Time dummies YES YES YES YES Sectoral dummies YES YES YES YES Reg. dummies YES YES YES YES Intercept -0.273 0.238 0.093 0.238 R2 .40 .41 .40 .41 N 594 594 594 594

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Results: “labor” regressions A

ln(Wage) B

ln(Social) C

Dwage E

Arrears Monopsony -0.032 -0.035 -0.005 0.001 ILO_unemploym 0.007 0.003 -0.018 0.002 Log(Reg_wage) 0.674*** 0.606*** -0.021 -0.003 Reg_arrears 0.280 0.284 -0.180 0.511*** Log(Sales) 0.009 0.011 -0.002 0.002 Power utilities -0.172*** -0.114* -0.015 0.004 Metallurgy -0.433* -0.258 0.216 0.011 Chemical -0.098 -0.051 0.053 -0.019** Machine building -0.361*** -0.247** 0.048 0.004 Light industry -0.246 -0.308 0.103* -0.001 Telecoms -0.336*** -0.280*** -0.042* -0.040*** Year 1998 0.062 0.102** 0.316*** -0.009 Year 1999 0.053 0.077* 0.085** -0.014** Year 2000 -0.034 -0.006 0.337*** 0.004 Year 2001 -0.002 -0.083 0.353*** 0.008 Year 2002 0.120* -0.008 0.346*** -0.002 Year 2003 0.155** -0.067 0.315*** -0.035*** Year 2004 0.240*** -0.031 0.361*** -0.009 Reg. dummies YES YES YES YES Intercept 2.099*** 1.023** 0.015 0.059 R2 .71 .62 .40 .42 N 594 594 594 594

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Results: wage residuals on VP residuals A B C D E VP_resid -0.009 0.134** 0.158*** 0.059 VP_resid X Control -0.155** Control 0.083 VP_resid X Cont_sh -0.178*** Cont_sh 0.104* VP_resid X Downer -0.001 Downer 0.003** VP_resid X Downer_1 0.096 VP_resid X Downer_2 -0.021 VP_resid X Downer_3 -0.012 VP_resid X Downer_4 -0.029 Intercept 0.000 -0.075 -0.096* -0.105** -0.001 Test VP_resid X Downer_1= F(1,140)=1.97 VP_resid X Downer_4 Prob>F=0.1629 R2 .00042 .019 .022 .033 .0059 N 594 594 594 594 594

Control=dummy for majority control; Cont_sh=dummy (majority control or owner1-owner2 >20%), Downer = owner1-owner2; Downer_1, etc. – quartiles of Downer

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Results: arrears residuals on VP residuals A B C D E VP_resid -0.157 -1.825* -2.194** -1.560* VP_resid X Control 1.829* Control -0.262 VP_resid X Cont_sh 2.204** Cont_sh -0.491 VP_resid X Downer 0.033* Downer -0.002 VP_resid X Downer_1 -2.112** VP_resid X Downer_2 -0.348 VP_resid X Downer_3 0.217 VP_resid X Downer_4 0.514 Intercept 0.000 0.248 0.467 0.114 0.030 Test VP_resid X Downer_1= F(1,140)=4.09 VP_resid X Downer_4 Prob>F=0.0452 R2 .00077 .0094 .012 .012 .015 N 594 594 594 594 594

Control=dummy for majority control; Cont_sh=dummy (majority control or owner1-owner2 >20%), Downer = owner1-owner2; Downer_1, etc. – quartiles of Downer

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Summary of the preliminary results Corporate governance and employment policies of firms are related. Workers seem to benefit (from higher wages, lower wage arrears) in

firms with severe corporate governance problems. Expropriation of investors implies more generous employment policies, and vice versa.

This result holds, however, only when firms are not majority owned (ownership structure is relatively dispersed).

When firms are majority controlled, there is no apparent relationship between the policies of managers (controlling shareholders) towards workers on the one hand and towards minority shareholders on the other hand.

The findings are in accord with several previous studies showing that expropriation of shareholders and employment policies may be linked via the market for corporate control.

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Thank you for your attention!