The Bright Side of Unionization: The Case of Stock Price Crash Risk

Abstract

This study examines whether and how labor unionization influences stock price crash risk. Using a regression discontinuity design that employs union elections as an exogenous shock yielding local variation in unionization, we find that unionization leads to a significant decline in stock price crash risk. We further explore the underlying mechanisms through which unionization affects crash risk and find that labor unions constrain managerial resource diversion and overinvestment, demand less risk-taking, and facilitate transparent information flow, which in turn reduces crash risk. Overall, our results suggest that unions play an important governance role. Our study sheds new light on a formerly under-researched beneficial impact of unionization and the role that organized labor plays in influencing extreme downside risk in the equity market.

The Importance of Director External Social Networks to Stock Price Crash Risk*

“…In relying on the agency perspective proposed in Jin and Myers (2006), prior empirical research implies that ex post realized stock price crash risk increases with opacity measured with absolute discretionary accruals (Hutton et al 2009), particularly accruals in more recent years and less reliable accruals (Zhu 2016). Crash risk rises when the bad news hoarding is more evident (e.g., complex tax strategies, Kim et al 2011a; more ambiguous annual reports, Ertugrul et al 2016 and Kim et al 2018; and real earnings smoothing, Khurana et al 2018) or when the incentives for suppressing bad news are stronger (e.g., executive equity‐based compensation, Kim et al 2011b; CEO overconfidence, Kim, Li et al 2016 and Kim, Wang et al 2016; and clawback provisions in compensation contracts, Bao et al 2018). Prior research identifies several formal control mechanisms that can curtail the extreme downside tail risk, including the passage of the Sarbanes‐Oxley Act (Fang et al 2010), financial reporting conservatism (Kim and Zhang 2016), effective internal control systems (Lobo et al 2020), the adoption of IFRS (DeFond et al 2015), and tighter monitoring by auditors through long‐term relationships with their clients (Callen and Fang 2017).…”

“…To control for real earnings management, we include abnormal production costs ( ABN_PROD T ), abnormal discretionary expense ( ABN_DISEXP T ), and abnormal cash flow from operations ( ABN_CFO T ) (Francis et al 2016). We also control for the presence of dividend payments ( DIV T ) (Kim et al 2018), auditor tenure ( TENURE T ) (Callen and Fang 2017), firm age ( AGE T ), director‐CEO ties forged through prior employment, education, or civic activities ( BOARD_CEO_TIE T ) (Bruynseels and Cardinaels 2014), and Big4 ( BIGN T ) and industry specialist ( SPEC T ) auditor status (Lim and Tan 2008; Reichelt and Wang 2010). We follow Callen and Fang (2013, 2015b) by controlling for the short interest ratio ( SIR_RATIO T ) and institutional ownership ( INST_OWN T ).…”

Managerial Political Orientation and Stock Price Crash Risk

“…B. Kim, Luo, & Xie, 2018). Hence, we expect firms run by Republican managers to have lower crash risk while firms run by Democratic managers to have higher such risk in general.…”

“…B. Kim and Zhang (2016) and Kim et al (2018) but provides new insights. The two studies document that increased accounting conservatism and reduced overinvestment, the latter of which is achieved through dividend payment, is followed by lowered crash risk.…”

Managerial Risk Tolerance and Corporate Credit Ratings.

“…Such excessive risktaking could increase the likelihood of failure and bankruptcy (e.g., Koharki, Ringgenberg, and Watson 2019). Also, the excessive risk-taking is an important mechanism that leads stock prices to crash (e.g., Bebchuk 2009;Chen, Kim, Li, and Liang 2018;Kim, Zhang, and Zhong 2019). As a result, firms with risk-tolerant CEOs are likely to have a lower level of future firm value and such firms are more likely to fail to service debt obligations (failure to pay interests in each period and principal at the maturity) in the future, which could in turn contribute to worse ratings.…”