Labor Unions, Operating Flexibility, and the Cost of Equity
56 Pages Posted: 21 Sep 2006 Last revised: 25 Aug 2012
Date Written: January 2009
We examine the impact of operating flexibility on firms' costs of equity by focusing on the constraints that labor unions impose on firms' operations. We find that the cost of equity is higher for firms in more unionized industries. The effect holds after we control for a host of industry- and firm-level characteristics, and is stronger when unions face a more favorable bargaining environment. The results are not driven by an industry life-cycle effect, unobservable time-invariant characteristics, and the magnitudes we estimated are robust to potential endogeneity concerns. The spread in the cost of equity between high- and low-unionization portfolios is highly countercyclical. Unionization is also positively related to various measures of operating leverage, and it is associated with both its labor and non-labor components. Our findings are consistent with the view that labor unions increase firms' costs of equity by decreasing their operating flexibility.
Keywords: labor unions, operating flexibility, cost of equity
JEL Classification: G12, J51
Suggested Citation: Suggested Citation