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How Labour Power Shapes Corporate Payout Policy
Research shows workforces trying to limit dividends are most successful in nations with broader collective bargaining and effective labour law enforcement
By Guy Haydon
Existing research shows that corporate payout policies are greatly influenced by the legal protection of shareholders and creditors. Yet in the past, less attention has been paid to labour – another important claimant to companies’ resources.
Workers, who prefer that companies hold on to profits rather than make cash payouts, have great potential to limit rent distribution among shareholders.
“The primary objective of labour is to maximize the present value of their expected future wages and benefits through excess rent extraction,” says Prof. Wu Donghui, Accountancy Professor and Director of Centre for Institutions and Governance at The Chinese University of Hong Kong (CUHK) Business School. Prof. Wu has recently been named by Abacus as the second most prolific author during 1999-2018 period, based on papers on the Chinese capital market published in Tier 1 journals.
His study “Having a Finger in the Pie: Labour Power and Corporate Payout Policy” examines the effect of labour power on business payout policy. With his fellow authors at the Texas Christian University, the Hong Kong Baptist University, and the University of Macau, the study utilizes data on labour laws with 41,436 firms in 39 countries from 1989 to 2015.
“We show shifts in labour laws governing collective labor relations have a significant impact on corporate payout decisions,” Prof. Wu says. “Basically, legislative changes that strengthen labour power reduce firms’ dividend payments and total payouts.”
Prof. Wu says the payout restriction effect of labor power is more pronounced in companies with greater labor intensity and in businesses operating in countries with broader collective bargaining coverage and more effective law enforcement.
“These results are consistent with the idea that the workforces of businesses seek to maximize their income through collective bargaining. Our findings show that labour power is another important country‐wide institution that shapes corporate payout policy,” he says.
The study’s data included an examination of the 2007-08 financial crisis – regarded as the worst crisis since the Great Depression of the 1930s – which hit financial markets worldwide and led the global economy into a prolonged downturn.
“The crisis, like a shock, abruptly lowers the available return on investment opportunities of firms in affected countries,” says Prof. Wu.
“To the extent that economic rents decrease sharply during a financial crisis, the constraint on company payouts imposed by labour power may become particularly severe.
“We used the crisis to generate additional evidence. Confirming that economic rents declined during the crisis period, the evidence enhances our confidence that our results were not spurious,” he says.
Strong labour power enables unions to take a tough stand in collective bargaining by making more rigid wage and benefit demands and imposing greater firing costs that, in turn, increase firms’ labour adjustment fees and decrease operating flexibility.
The strength of union bargaining power increases with the proportion of staff covered by collective bargaining.
When firms facing strong labor unions are subject to lower operating flexibility, managers may cut dividends and conserve cash to regain some operating flexibility.
The study contrasted before-and-after differences in payouts of firms that saw a change in labour laws in a given year with the before-and-after differences in payouts of businesses that did not experience such a change in the same year and industry.
Labour regulation changes are often triggered by changes in a nation’s government. Changes in political leadership often lead to legislation, including labour laws, being revamped.
For example, in France, the newly elected President Emmanuel Macron’s government launched an overhaul of French labor laws in September of 2017 – the first of a number of reforms he promised would help revive the economy.
Reforms to labour laws also can be linked to business cycles in a country; stricter labor protection legislation is often passed or retained in periods of economic contractions, while governments may ease labour rules that deal with unemployment during a period of low economic growth.
A nation’s labour laws are also shaped by the type of political party in power: labor regulations are more protective of workers when leftist governments are in power, while the political leaning of a government may also influence a company’s policy and regulation decisions.
“Our findings suggest that strong labour power alone does not cause a reduction in total payouts. Rather, it is the bargaining power in conjunction with rigid employment laws that leads to reductions in the total payouts.” – Prof. Wu Donghui
Prof. Wu says the study found that, as enforcement of labour laws rests with governments, labor bargaining power increases with the extent of law compliance. It means the effect of labour power on profit distribution is more salient in countries with more effective law enforcement.
The findings of the study, compiled after the data was used in a series of complicated statistical calculations, took into account many variables including a company’s cash holdings, profitability, financial leverage, and a nation’s gross domestic product growth and economic and equity market development.
“Our findings suggest that strong labour power alone does not cause a reduction in total payouts,” says Prof. Wu. “Rather, it is the bargaining power in conjunction with rigid employment laws that leads to reductions in the total payouts.
“We found that the effect of labour power on corporate payouts is not a purely mechanical profitability effect. Tightened operating flexibility and excess rent sharing are two channels through which labour power affects payouts,” he says.
“We also found that firms operating in more developed financial markets make greater payouts, and that businesses cut dividends and total payouts after a change in labour laws that grant more power to labour, compared with a set of control firms in the same industry at the same time, but based in nations without labour law changes,” he adds.
Prof. Wu says the study adds to a growing body of international studies examining the economic impact of country-wide laws or law changes.
“We have complemented this literature by demonstrating that shifts in labor laws governing collective labour relations have a significant impact on a firm’s payout decisions,” says Prof. Wu.
Director, Centre for Institutions and Governance