Management-Employee Alliance and Earnings Opacity

Abstract

The rise of stakeholder governance has triggered a wave of legal initiatives to strengthen employee voice in firms. Exploiting staggered employment protection laws (EPLs) across 26 countries, we find that managers facing strong EPLs report more opaque earnings. Exploring the mechanism, we show that EPLs induce manager-employee alliance: by enhancing employees’ power to influence managers’ private benefits, EPLs create an incentive for managers to ally with employees and treat them more favorably, leading to an increase in manager-employee reciprocal benefits. Next, we show that manager-employee alliance drives the increase in opacity following EPLs. Such alliance-induced opacity impedes the ability of institutional shareholders to make timely adjustments to portfolio holdings in response to EPLs. Lastly, we identify several governance mechanisms that help break manager-employee nexus and restore reporting transparency. Overall, our study documents manager-employee alliance as a potential cost of rigid labor laws and an important source of managerial reporting bias.

Keywords: Labor protection; earnings quality; reciprocal benefit; stakeholder governance

JEL Classification: F01, J01, K01, M41, M43