Federal Reserve Bank of New York Staff Reports

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1 Federa Reserve Bank of New York Staff Reports ESOP Fabes: The Ipact of Epoyee Stock Ownership Pans on Labor Disputes Peter Craton Haid Mehran Joseph Tracy Staff Report no. 347 Septeber 2008 This paper presents preiinary findings and is being distributed to econoists and other interested readers soey to stiuate discussion and eicit coents. The views expressed in the paper are those of the authors and are not necessariy refective of views at the Federa Reserve Bank of New York or the Federa Reserve Syste. Any errors or oissions are the responsibiity of the authors.

2 ESOP Fabes: The Ipact of Epoyee Stock Ownership Pans on Labor Disputes Peter Craton, Haid Mehran, and Joseph Tracy Federa Reserve Bank of New York Staff Reports, no. 347 Septeber 2008 JEL cassification: J52, C78, D82 Abstract By the eary 1990s, epoyee stock ownership pans (ESOPs) had becoe as prevaent in unionized firs as in nonunionized firs. However, itte research has been devoted to exaining the ipications of ESOPs for coective bargaining or, ore generay, for cross ownership. In this paper, we extend the signaing ode of Craton and Tracy (1992) to aow partia ownership by the union. We deonstrate that ESOPs create incentives for unions to becoe weaker bargainers. As a resut, the ode predicts that ESOPs wi ead to a reduction in strike incidence and in the fraction of abor disputes that invove a strike. We exaine these predictions using U.S. bargaining data fro 1970 to The data suggest that ESOPs do increase the efficiency of abor negotiations by shifting the coposition of disputes away fro costy strikes. Consistent with iproved bargaining efficiency, we find that the announceent of a union ESOP eads to a 50 percent arger stock arket reaction when copared with the announceent of a nonunion ESOP. Key words: coective bargaining, ESOP, cross ownership, incopete inforation, strikes, abor disputes Craton: University of Maryand (e-ai: pcraton@gai.co). Mehran: Federa Reserve Bank of New York (e-ai: haid.ehran@ny.frb.org). Tracy: Federa Reserve Bank of New York (e-ai: joseph.tracy@ny.frb.org). Michae Suher provided exceent research assistance. The authors woud ike to thank Saeyoung Chang, David Mayers, Susan Chapinsky, Greg Niehaus, and Dougas Shackeford for providing data. They aso benefited fro hepfu discussions with Anup Agrawa, Karen Edunds, Dianne Eberein (for industry insights), Yaniv Grinstein, Caroa Frydan, Mark Ubehart, Linda Fisher, Judy Lindquist, Aen Steinberg, Shei Greensade (Hewitt Associates), Eyse Buth (Duff & Pheps), David Powe (Groo Law Group, Chartered), Michae Keeing (the ESOP Association), and Cory Rosen (Nationa Center for Epoyee Ownership). In addition, the authors benefited fro conversations with seinar participants at SOLE, the University of Wisconsin, an MIT workshop on Appied Econoics, a Yae seinar series on Law and Econoics, the Mitsui Life Financia Research Center at the University of Michigan, the Financia Manageent Association, the Association of Financia Econoists, and New York University Law Schoo. The views expressed in this paper are those of the authors and do not necessariy refect the position of the Federa Reserve Bank of New York or the Federa Reserve Syste.

3 The growth in Epoyee Stock Ownership Pans (ESOPs) in the 1980s fostered a considerabe iterature into the reasons for their adoption and their ipacts on the adopting fir. ESOPs are quaified pension pans that were given expicit recognition and tax incentives by the Epoyee Retireent Incoes Security Act of 1974 (ERISA). In 1980, 4,925 ESOP pans existed covering approxiatey 5.3 iion workers. By 1995, the nuber of pans had increased to 9,232 with coverage expanding to 7.2 iion workers. 1 Beginning in 1988, it is possibe to identify ESOPs that are estabished as a part of a coective bargaining agreeent. As of 1991, union ESOPs covered 1.1 iion workers, 6.6% of a private sector workers covered by coective bargaining agreeents. In the sae year, nonunion ESOPs covered 5.5 iion workers, 6.4% of a private sector nonunion workers. 2 That is, by the eary 1990s ESOPs had becoe as prevaent in unionized as in nonunionized firs. Despite the reative prevaence of ESOPs in unionized firs, there has been very itte research on the ikey ipact of ESOPs on coective bargaining. Ben-Ner and Jun (1996) deveop a screening ode of bargaining that aows the union to use an ESOP to buy a ajority equity stake in the fir. In their ode, during a contract negotiation the union s initia offer to the fir consists of a wage deand and a buyout price. High vauation firs accept the wage deand with no abor dispute, ow vauation firs accept the buyout price again with no abor dispute, and abor disputes screen the reaining interediate fir types. The buyout option owers the overa dispute rate and dispute duration by providing the union with an additiona screening device. Whie incuding ESOPs as a buyout option in a screening ode is an interesting theoretica extension, this option is rarey exercised in practice. Figure 1 shows the distribution of ESOP ownership shares in our data of ESOPs at unionized firs. Less than three percent of these ESOPs invove a controing interest in the fir. 3 The ownership share for the typica union ESOP is substantiay beow 50%. In this paper, we exaine the ipact of ESOPs on the coective bargaining process when the union has a noncontroing ownership interest in the fir. This confors to neary a union 1 See DOL (1999). 2 We thank Doug Kruse for tabuating the nuber of participants in coectivey bargained ESOPs fro the IRS For 5500 data. 1

4 ESOPs observed in the data. Rather than focusing on the adoption of an ESOP as a bargaining outcoe, we focus instead on the effect that an existing ESOP has on current contract negotiations. We do this by extending the signaing ode of Craton and Tracy (1992) to aow the union ebers to hod an equity stake in the fir. The ESOP causes the union to internaize to a degree the costs to the fir associated with abor disputes. As the union s equity stake grows, we show that the union is ess ikey to seect the strike threat and that the fir is ore ikey to accept the union s initia wage offer. ESOPs, then, are predicted to shift the coposition of disputes fro strikes towards hodouts. 4 We test these predictions using a sape of U.S. contract negotiations. Unionized firs that adopt an ESOP do not appear to have any significanty different bargaining experience prior to the ESOP adoption than unionized firs that do not adopt an ESOP. The data indicate a decine in the incidence of strikes foowing the adoption of an ESOP. In addition, foowing the adoption of the ESOP these firs experience a reduction in the fraction of abor disputes that take the for of a strike. The data are consistent with ESOPs atering the reative attractiveness of the strike and the hodout threats. The signaing ode predicts that ESOPs shoud iprove the efficiency of coective bargaining by reducing the incidence of costy strikes. This iproved bargaining efficiency creates vaue for the fir s sharehoders over and above any of the traditiona arguents for why ESOPs shoud ead to higher profitabiity. This suggests that the announceent of a union ESOP shoud generate a arger stock arket reaction than for the announceent of a non-union ESOP. We test this prediction by conducting an event study of ESOP adoptions. We find that the announceent of a union ESOP eads to a differentiay arger stock arket reaction as copared to the announceent of a non-union ESOP. More generay, an ESOP can be thought of as an exape of cross ownership. Cross ownership ties the success of each copany to its partners. As a resut, the copanies have better incentives in negotiating and investing in ong-ter suppy reationships. Bargaining costs are reduced and the copanies enjoy a ore productive coaboration. Our anaysis is reevant to 3 The best known exape of unions using an ESOP to gain a controing interest in a copany was the union buyout of United Airines in Cott and Stuart (1995) provide a usefu suary of this buyout. 4 Hodouts are abor disputes in which the union agrees to work under the ters of the expired abor agreeent whie negotiations continue. In a hodout, the union puts pressure on the fir using a variety of tactics such as work-to-rue. 2

5 the study of cross ownership. The paper is organized as foows. In the next section we describe iportant features of ESOP pension pans. In section 3, we show how ESOPs can be added to a signaing ode of abor contract negotiations. We discuss the data and present our findings in section 4. We conduct in section 5 an event study of the announceent of a new ESOP to expore the ipications of ESOPs for the fir's sharehoders. The fina section contains thoughts for future work. 2. A prier on ESOPs ESOPs were foray sanctioned in 1974 as a type of retireent pan under ERISA. A fir that wants to set up an ESOP estabishes a trust fund in which to ake contributions. These contributions are aocated to individua worker accounts hed by the trust. Aocation foruas vary in practice but are based on factors such as the worker's eve of copensation and years of service. Vesting of assets aocated to worker accounts takes one of two fors: no vesting for the first five years, foowed by 100% vesting; or 20% vesting after three years, and 20% per year for the next four years. The nondiscriination requireent stipuates that highy copensated epoyees cannot account for ore than 30% of participants in the ESOP. 5 An iportant feature of ESOPs for understanding their incentive effects for coective bargaining is that at east fifty percent of the ESOP's assets ust be invested in the epoyer s securities. Whie other deferred copensation pans ay in fact hod significant aounts of epoyer securities, they are not copeed to do so. Workers with 10 years of pan participation can begin to diversify their ESOP account when they reach age This diversification option continues unti the worker reaches age 60, when he/she is given a one-tie option to diversify up to 50% of his/her account. 7 The epoyee receives the vested assets in his/her account at the end of the epoyent reationship with the fir. 8 Shares in an ESOP are egay owned by the ESOP trust. The contro rights to these 5 Quaified pans ust eet nondiscriination tests regarding (a) coverage and (b) nondiscriination in pans features. Each of these tests can be et through a variety of tests. Pans covering coectivey bargained epoyees are effectivey exepted fro these rues. 6 See Oringer (2001). 7 This requireent appies to ESOP shares aocated to worker accounts after Deceber 31, See 3

6 shares reside in the trustee of the pan, who is typicay appointed by anageent. The trustee of the ESOP votes a nonaocated shares. In pubic copanies, the pan participants ust be aowed to vote their shares on voting issues. 9 Fiduciary decisions, for exape the consideration of a tender offer, need not be passed through to the participants. However, the ESOP can be set up so that this authority is given to the pan participants for decisions on aocated shares. Most pubic copanies do structure their ESOPs in this anner (Rosen, Snyder, and Young 1993). Motives for adopting an ESOP have been expored in the iterature. First, Deaware aw akes ESOPs a potentia takeover defense. 10 A fir incorporated in Deaware ust wait three years after it acquires 15% of the target fir s equity before it can erge with the target, uness it can obtain a waiver by 85% of the sharehoders. In 1989, Poaroid won a decision in Deaware Court that uphed the copany decision to issue 14% of its stock to an ESOP prior to the initiation of a hostie tender offer by Sharock Hodings. Manageent ay fee that giving voting rights to the union through an ESOP is a way of pacing the votes in friendy hands (e.g., Chang and Myers 1992 and Chapinsky and Niehaus 1994). Second, ESOPs were given specia tax incentives in order to encourage their adoption. The specifics of these tax benefits, though, are not directy reevant for our purpose. Interested readers can find a detaied discussion in Beatty (1995) and Schoes and Wofson (1990). Finay, ESOPs ay iprove worker productivity by giving workers an equity stake in the fir. Considerabe effort has been devoted to pinning down the productivity effects of profit-sharing in genera, and ESOPs in particuar (Kruse 1993, Be and Kruse 1995, and Kruse and Basi 1995). The net ipact of ESOPs on a fir's profitabiity can be assessed by conducting an event study of the announceent effect of a new ESOP. The announceent of a new ESOP on average is viewed in a positive ight by investors. Studies have found that the average two day cuuative excess stock return on the day prior to and the day of an ESOP announceent ranges fro one to three percent (Gordon and Pound 1990 and Beatty 1995) I.R.C. 4975(e)(7) (1989). 10 Genera Corporation Law SS 203, effective 2 February This announceent effect captures ore than just the tax benefits of an ESOP since it has been docuented that stock prices react positivey to ESOP adoption even when there is no tax benefit (and adopting copanies are takeover targets). See Seers, Hagan, and Siege (1994) for further discussion. 4

7 3. Incorporating ESOPs into a bargaining ode It is often argued that ESOPs serve to iprove worker incentives by giving individua workers ownership in the fir. The difficuty with this arguent is that any given worker s perforance has ony a negigibe ipact on the fir s profitabiity. A rationa worker, outside of top anageent, shoud not ater his/her behavior as a resut of an ESOP. However, the ipact of even a sa ESOP on coective bargaining can be draatic. This is because coective bargaining avoids the dissipation of incentives that is seen at the individua worker eve. As a resut, the presence of an ESOP wi affect the union s wage deand and its decision to strike. To assess the ipact of an ESOP on coective bargaining we extend the wage bargaining ode of Craton and Tracy (1992). The ode assues one-sided private inforation in which the union is uncertain about the fir s profitabiity. The fir crediby signas its profitabiity through its wiingness to postpone agreeent. The union decides how best to pressure the fir by seecting the threat, either strike or hodout. Under hodout, the union continues to work under the ters of the expired abor agreeent, but at a reduced eve of efficiency. In contrast, striking typicay invoves a substantia disruption of production. We wi see that an ESOP ipacts not ony wages, dispute incidence, and dispute duration, but aso the for the dispute takes. Consider the foowing styized abor contract negotiation probe. A union and a fir are bargaining over the wage to be paid during a contract of duration T. Let v be the fir s vaue of the current union abor force working under a contract of duration T. It is coon knowedge that v is drawn fro the distribution F with positive density f on an interva of support [, h]. However, at the outset of the negotiations ony the fir knows the reaized vaue of v. Negotiations begin with the union seecting a threat {H,S}, where H indicates the hodout threat and S indicates the strike threat. The union s threat choice reains in effect unti a setteent is reached. Absent an ESOP, in the threat, the payoff to the union is x and the payoff to the fir is a v b, where a [0,1) and b 0. The ter 1 a captures the dispute cost in that threat. Define c = (b x ) / (1 a ) to be the reative payent difference during the threat. Since the tota payoff in agreeent is v and the tota payoff during the threat is a v b + x, the pie that the union and fir are bargaining over (the difference between the agreeent and the threat payoffs ) is (1 a )v + b x = (1 a )(v + c ). We assue that the 5

8 pie is positive for a v [, h], which ipies that c >. Let w 0 denote the wage under the expired abor agreeent. Since the ters and conditions of the previous abor agreeent reain in force during a hodout, the workers continue to be paid w 0 during the hodout, so x H = b H = w 0 and c H = 0. We assue there is soe inefficiency during a hodout, a H < 1. With an ESOP, the union gets a share α of the profits of the fir. This changes the payoff fows both during the threat and after setteent as shown in Figure 2. The outcoe of this bargaining process between the union and the fir denoted by t, w, consists of the tie of the setteent t where t [0,T], the wage setteent w and the threat seected by the union. The union and fir payoffs are cacuated as the su of the threat payoffs and the agreeent payoffs, weighted by the fraction of tie spent in each state. Define 1 e Dt () = 1 e rt rt to be the discounted fraction of tie spent in dispute if an agreeent occurs at tie t. Then, given the bargaining outcoe t, w,, the union s payoff is Utw (,, ) = [ x+ α( av b)] Dt () + [ w+ α( v w)][1 Dt ()] and the fir s payoff is Vtw (,, ) = (1 α)( av b) Dt ( ) + (1 α)( v w)[1 Dt ( )]. Notice that the ESOP does not change the fir s incentives. The fir sti seeks to axiize its overa profits, despite the fact that a share α of these profits is going to the union. In contrast, the ESOP does fundaentay change the incentives of the union. With an ESOP, the union cares not ony about its wage, but aso about the fir s profitabiity, which fas with higher wages and onger and ore costy abor disagreeents. As a resut, the ESOP akes the union a ess deanding negotiator. As we wi see, the ESOP gives the union an incentive to seect a ess destructive threat and to deand a ower initia wage deand. 6

9 The bargaining sequence is as foows. Foowing the union s threat choice the union and the fir aternate aking wage offers, with the union assued to ake the initia offer. After a wage offer is ade by one side, the other side has two options: (1) ake a counteroffer, in which case the bargaining continues, or (2) accept the current offer, in which case the bargaining ends and abor is suppied at the offered wage for the reinder of the contract period. As in Adati and Perry (1987), a bargainer can deay responding to an offer. This assuption eads to the signaing equiibriu in which the fir signas its vaue through its wiingness to deay the agreeent. For sipicity, we assue that the iniu tie between offers is arbitrariy sa. The equiibriu of this bargaining gae takes a sipe for. If the wage under the expired abor agreeent, w 0, is sufficienty ow (that is, beow soe indifference eve w% ) the union decides to seect the strike threat; otherwise ( w 0 w% ) the union seects the hodout threat. The indifference eve wage, w%, depends on r, T, F, the strike and hodout threat payoffs and the ESOP size α. A second indifference eve, (, h), deterines the fir s response to the union s initia wage offer. If the fir s vauation is higher than this indifference eve, v >, the fir accepts the union s initia wage offer and an iediate setteent takes pace. Otherwise, the fir rejects the union s initia wage offer and a abor dispute begins. Whether the dispute is a strike or a hodout depends on the union s prior threat choice. Appendix A. The signaing equiibriu is characterized by three propositions, which are proven in Proposition 1. Let be the threat chosen by the union. In the iit as the tie between offers goes to zero, there is a perfect Bayesian equiibriu with the foowing for: The union akes an iediate offer of (c ) (, h) axiizes (M) 1 2α w( ) = x + (1 a )( c ) 2 2α + 2 2α 1 2α ( v + c ) (1 2 α)( + c)(1 F( )) + ( 2 α( v + c)) df( v). ( + c ), where v + c + c 1 2 The fir accepts the offer if v. Otherwise, if v < the fir waits unti ( ) α of the contract period reains before offering accepted by the union. 1 2α w() v = x + (1 a)( v + c) 2 2α, which is 7

10 Severa observations foow fro Proposition 1. First, a wage offers are Rubinstein (1982) fu inforation wage offers. The wage offer consists of the union s payoff in the threat, x, pus the fraction 1 2 α of the bargaining rents (the avoided oss) based on the fir s 2 2α profitabiity, v (or in the case of the union s initia offer). For bargaining units without an ESOP (α = 0), the rents are spit equay between the union and the fir with the union receiving its share of the rents entirey through the setteent wage. At the other extree, for bargaining units with a controing interest in the fir (α = ½), there is no onger any bargaining confict between the fir and the union. The union receives a copetitive wage equa to its threat payoff, x. However, the union sti coects haf of the rents, v - x, though it now receives the payent entirey through its equity stake. For interediate vaues of α, the union receives soe of its rents through the wage and soe through its equity stake. Second, during a abor dispute the union has every incentive to ipose as uch inefficiency on the fir as possibe. The wage under both threats increases ineary with the degree of inefficiency, but the strength of this incentive diinishes with α. For a given threat, we can deterine how the dispute incidence and duration respond to changes in the distribution of v, changes in the threat payoffs, or to changes in the size of the ESOP. The foowing proposition says that dispute activity increases with uncertainty. In addition, dispute activity increases when the threat becoes ore attractive to the union (i.e., c fas). However, dispute activity decreases with arger ESOPs (as α rises). Proposition 2. Suppose that uniquey axiizes (M). Dispute incidence F() and dispute v + c + c 1 2 duration Dv () 1 ( ) α increase with a inear, ean-preserving spread of the distribution of F. Moreover, dispute incidence and duration decrease as c increases and as α increases. Dispute activity depends on the aount of uncertainty about the fir s private inforation. Dispute incidence aways exceeds one-haf, and converges to one-haf in the iit 8

11 as uncertainty disappears. 12 Reca that c easures what the fir pays ess what the union receives in the threat scaed by the dispute cost. Proposition 2 yieds severa testabe predictions. For exape, if a oca union receives strike benefits throughout a strike fro its nationa union (and the costs of the benefits are spread across the nationa ebership), then this owers c S which shoud increase strike incidence and engthen strike durations. Siiary, if workers on strike quaify for genera wefare payents, this aso owers c S and shoud increase the incidence and duration of strikes. The intuition for why ESOPs reduce dispute incidence and dispute duration stes fro the fact that as α increases the union s preferences becoe ore in ine with the fir. A bargaining unit without an ESOP receives rents ony through the negotiated wage. Labor disputes are a costy activity that aows the union to raise its wage. A bargaining unit with an ESOP no onger coects its rents entirey through the negotiated wage. Depending on the size of the ESOP, a portion of the union s rents is now coected through its ownership stake in the fir. As the ESOP share α increases, the union coects a higher share of its rents through its equity stake, which dapens the union s incentive to invest in costy abor disputes in order to raise its wage. At α = ½, a of the union s rents are coected through its equity stake and there is nothing eft to disagree about. Consequenty, dispute incidence and duration vanishes to zero. Our third proposition deonstrates that the union s threat decision depends criticay on the current wage under the expired abor agreeent, w 0. Proposition 3. If 0 w hodout threat, where < w%, the union seects the strike threat; if 0 w w% the union seects the w% = x + (1 a )( + c )(1 F( )) (1 a ) (1 F( )) S S S S S H H H S H α ( cs(1 as) F( S) + (1 as) vdf( v) (1 ah) vdf( v)) 1 α and S = (c S ) and H = (c H ) axiize (M). 12 By dispute incidence we ean the ikeihood that either a strike or a hodout takes pace. Dispute incidence ess than one-haf resuts when there is a fixed cost to initiating a dispute. 9

12 The intuition is that the union wi seect the strike threat if and ony if the higher bargaining costs that are associated with a strike are ore than ade up for by a higher wage. If the current wage under the expired abor agreeent is sufficienty high, this is not the case and the union prefers the hodout threat. Proposition 3 provides a key insight into strike activity. The overa incidence of strikes depends not just on the overa incidence of disputes, but aso on the fraction of disputes that invove a strike. As shown earier, the eve of dispute activity depends on the degree of uncertainty and the size of the ESOP. The coposition of disputes between strikes and hodouts depends on 0 w, the size of the ESOP, the threat payoffs and the ocation of the distribution of v. We woud ike to deterine how the size of the ESOP ipacts the coposition of disputes. An exaination of the Rubinstein wage provides soe insight: 1 2α w() v = x + (1 a)( v + c) 2 2α. We see that as α increases, the wage under both threats fas. However, assuing that the strike threat is uch ore destructive than the hodout threat (a S << a H ), then it is the case that as the ESOP share increases the wage under the strike threat is faing uch faster than the wage under the hodout threat. A higher ESOP share reduces the reative wage gap between the strike and the hodout threats. Hence, we shoud expect that an ESOP shoud increase the reative attractiveness of the hodout threat. The incentive to strike is further reduced when the union factors in the dispute costs. The ess destructive threat, hodout, resuts in ower dispute costs. Thus, our intuition is that we shoud expect ESOPs to shift the coposition of disputes away fro strikes. This intuition is difficut to estabish without aking further assuptions on the threat payoffs. One usefu sipification is Assuption S. b S = x S. This states that what the fir pays out during a strike is equa to what the union receives 10

13 ipying that c S = In the case of hodout, reca that the fir pays the union the wage fro the expired contract, which eans b H = x H = w 0, and c H = 0. Thus, with Assuption S, c H = c S = 0, which ipies that the union seects the sae cutoff eve under either threat ( = S = H ). As a resut, the incidence and duration of the dispute is the sae under either threat. Since a S < a H, it iediatey foows that the expected oss fro a strike is higher than the expected oss fro a hodout. In addition, we can show Proposition 4. Suppose Assuption S hods and is the unique axiizer of (M). Then as α increases fro 0, w% fas and the union is ore apt to choose the hodout threat. Moreover, if v is unifory distributed, then for a α, the union s threat choice shifts toward hodout as the size of the ESOP grows. Propositions 1 4 yied a nuber of predictions about how coective bargaining changes with the introduction of an ESOP. As a union s equity position in the fir grows, we shoud expect fewer and shorter disputes. Moreover, the union shoud be ess apt to seect the ore destructive strike threat, and thus strike incidence shoud be ess. To get a sense of the agnitude of these effects, we set the ode paraeter vaues to the benchark eves of Craton and Tracy (1994). These paraeter vaues were caibrated such that the equiibriu outcoe with α = 0 (no ESOP) fits the descriptive statistics of private-sector coective bargaining in arge (ore than 1,000 workers) private-sector bargaining units in the U.S. fro 1970 to Figure 3 shows how dispute incidence changes in the benchark ode with the introduction of an ESOP. Overa dispute incidence decines sowy as the ESOP ownership share increases fro 0 to 25 percent. However, there is a substantia change in the for that disputes take, resuting in a arge decine in strike incidence. Strike incidence, initiay at 11 percent with α = 0 fas roughy ineary to 0 at α = This decine in strike incidence is the resut of the union avoiding the ore costy strike threat when the union has an equity interest in 13 Assuption S can hod in a variety of situations. If the fir coses down during a strike and the union workers do not find aternative epoyent, then the assuption hods. Siiary, if the fir hires repaceents at a copetitive wage and the striking workers find aternative epoyent at the copetitive wage then the assuption aso hods. 14 Specificay, we assue v is unifor on 1 ± 0.07, w 0 is unifor on 0.48 ± 0.05, a S = 0.75, a H = 0.96, x S = b S = 0.35, r = 10%, and T = 2.7 years. 11

14 the fir. Figure 4 shows how the expected oss fro disputes decines as the union s ESOP ownership share increases. The expected oss conditiona on the strike threat is cut in one-haf as α increases fro 0 to 0.25 this is the consequence of the ean strike duration dropping fro 36 days at α = 0 to 18 days at α = However, the expected oss fro disputes drops by a factor of ore than four as α increases fro 0 to The faster decine in the dispute oss is the resut of two sources of reduction as the union s equity interest increases: 1) shorter disputes and 2) the shift away fro the ore costy strike threat. The decine in dispute costs with the introduction of an ESOP raises the possibiity that both the union and the fir ay benefit fro the ESOP, a ese equa. In our benchark ode, this is not the case. With α = 0, the union and fir spit the pie roughy equay, but as the union s ownership share increases to 20 percent, the spit shifts to 60/40 in favor of the union. This suggests that firs woud offer ESOPs ony in conjunction with soe cobination of tax breaks and concessions by the union. To suarize, the benchark ode caibrated to fit the ain features of U.S. coective bargaining suggests severa hypotheses: 1) ESOPs shoud resut in ower strike incidence, strike duration and fraction of disputes invoving a strike, 2) ESOPs shoud resut in ower expected dispute costs, and 3) ESOPs shoud be associated with union concessions. The size of the ESOP ipact depends on the union s ownership share of the fir. According to the benchark ode, the average ipact of ESOPs based on the observed distribution of ESOP shares (see Figure 1) is as foows: dispute incidence fas fro 51.8 to 51.6 percent, strike incidence fas fro 11.1 to 5.5 percent, and the union s seection of the strike threat fas fro 21.4 to 10.7 percent. 4. ESOP data and epirica findings Our priary data source for ESOP inforation was the Nationa Center for Epoyee Ownership (NCEO). For each pubicy hed corporation, we used NCEO data to deterine whether an ESOP exists, the date the ESOP was adopted, and the percent of tota shares hed by the ESOP. We sent surveys to 387 corporations where there was any indication of possibe error in the NCEO data. A tota of 268 copanies responded to the survey, athough about a third of responses were not inforative since the pan adinistrators caied that they did not have 12

15 inforation about the specific circustances surrounding the adoption of their ESOPs. We ade corrections to the data based on the usabe survey responses. In addition, we checked the accuracy of our ESOP data against those reported in Chang and Mayers (1992), Gordon and Pound (1990), and Chapinsky and Niehaus (1994). Finay, we cross-checked our data with the inforation provided to the Interna Revenue Service in the For We were unabe to check the accuracy of ESOPs that were put into pace before 1988 due to the fact that any of these copanies were subsequenty deisted. Our fina ESOP sape for which we have copete data consists of 142 firs. Our coective bargaining data consists of a private sector ajor bargaining units foowed by the Bureau of Labor Statistics (BLS) fro 1970 to The BLS copies setteent, effective, and expiration dates for each round of contract negotiations. Strike beginning and ending dates are fro BLS and Bureau of Nationa Affairs data, and consist of copiations fro pubic sources. Each bargaining unit is assigned a unique identification nuber by the BLS. A tota of 1,101 bargaining units and 6,585 negotiations are captured in the data. Since our ESOP data ony covers pubic copanies, we restrict our sape to this set of firs. CUSIP nubers were erged in using the fir nae isted by the BLS and data sources on ergers and acquisitions during the sape period. Vaid CUSIP nubers were avaiabe for 4,635 negotiations invoving 715 bargaining units. A fu set of contro variabes (described beow) were avaiabe for 3,994 contract negotiations. We erged the sape of ESOPs into our coective bargaining data using the fir s CUSIP nuber. This erging had to be done with care to take account of any ergers and acquisitions, as we as instances where firs se-off or acquire divisions that are covered by coective bargaining. 17 For exape, a division of a copany with its bargaining units covered 15 Every ESOP invoving ore than 100 participants ust fie a For 5500 report with the Interna Revenue Service. Beginning in 1988, the For 5500 data indicate if the ESOP is part of a coective bargaining unit. 16 Major bargaining units cover 1,000 or ore workers. The BLS stopped coecting bargaining data on ajor bargaining units at the end of If the fir is being acquired then the treatent of its ESOP is siiar to a 401(k) pan -- the assets woud be oved into a successor pan, usuay a 401(k) in the acquirer. That pan ight se the shares if it is a arge percentage of the acquirer s stock. Aternativey, the shares coud be cashed out and epoyees coud ro the into an IRA or pay taxes and keep the oney, or the epoyees coud sipy be given the shares. 13

16 by an ESOP ay be sod to another copany with no ESOP (or, aternativey, the division ay go through a anageent/everage buy out). 18 For our anaysis, we tracked bargaining units and whether they are covered by the origina ESOP pan. We used Standard & Poors Copustat and Center for Research in Securities Prices (CRSP) as priary source of data for tracking firs and divisions. For additiona background detai, we used Securities Data Corporation data on asset se-offs for restructuring in the 1990s, Moody s Manuas, 10-Ks fied with the SEC, and Directory of Corporate Affiiates. Finay, we aso deeted a contract negotiations in the airine and rairoad industries since their bargaining is covered by different statutory and case aw. The pattern of adoption of ESOPs over tie in our data is presented in Tabe 1. Of the 142 tota ESOP pans that we inked to our bargaining data, around 2% were put into pace in the year foowing the passage of ERISA. In the eary to id-1980s soe ESOPs were put into pace as part of concession bargaining by the fir. 19 Adoption rates significanty picked up in 1989, foowing the enhanceent of soe of the ESOP tax incentives and the Poaroid decision. Overa, ESOPs were adopted by 22% of the bargaining units in our data. A tota of 74% of contract negotiations invove firs that never adopt an ESOP. For the bargaining units invoving firs that adopt an ESOP, the negotiations prior to the adoption date represent 16% of the tota sape, whie the negotiations foowing the adoption date represent 10% of the tota sape. The fact that any ESOPs are adopted ate in our sape period ipies that we shoud interpret any estiated ipact as a short-run effect. Tabe 2 gives the distribution of ESOPs across broad industry cassifications. The 18 A copany that ses a division has a few options: (a) without affirative epoyer action, the affected epoyees are treated as any terinated epoyees. The vested epoyees can then receive distributions pursuant to the pan's genera provisions, and unvested epoyees forfeit their interest. (b) the copany coud choose to vest a epoyees, and otherwise treat the epoyees under (a) above. (c) the epoyer coud retain the funds in the ESOP, and give continuing vesting service for epoyent with the buyer. Under any of these options, the epoyer ight aso faciitate roovers to the buyer s pan (after iquidating the stock). Aternativey, the seer coud ipeent a trust-to-trust transfer to the buyer's pan (again, with or without fuy vesting--but usuay after vesting). If a trust-to-trust transfer occurs, the buyer can either retain the stock fund (but freeze it) to enabe the participants to retain favorabe tax treatent (on net unreaized appreciation) upon distribution. However, ost epoyers woud prefer to iquidate the stock fund quicky. It shoud be noted that a partia terination requires fu vesting. A partia terination occurs if a significant percentage of a pan's popuation is terinated as the resut of epoyer action. Over 50% terination is aways a partia terination, under 20% is never a partia terination and anything between 20% and 50% is subject to evauation based on facts and circustances. 19 See Fanagan (1984) for exapes. 14

17 incidence of adoption aong unionized firs is not unifor across industry cassifications, and is reativey high in Petroeu & Coa and Transportation Equipent. By way of coparison, Be and Kruse (1995) using For 5500 data find that the overa incidence of ESOPs was 72.7% in Counications, 39.2% in Utiities, 11.3% in Manufacturing, and 11.7% in Finance, Insurance, and Rea Estate. Be and Kruse report that the incidence of ESOP adoption is three ties higher in high technoogy sectors than for the private sector as a whoe. To investigate the ipact of ESOPs on the coective bargaining process, we estiate strike incidence, dispute incidence and dispute coposition specifications using probit odes. These specifications aow us to contro for fir-specific and cycica effects on bargaining, changes in bargaining patterns over tie, and factors specific to each industry and union that ay ipact bargaining outcoes. We contro for fir size and profitabiity. We use the og of the fir s assets as our size easure, where inforation on fir assets is taken fro the Standard & Poors Copustat database. We capture fir profitabiity using the firs reported net incoe for the year prior to the contract negotiation. Inforation on the fir s net incoe is aso taken fro Copustat. 20 A of our probit specifications contro for possibe cycica patterns in bargaining using aggregate, industry and oca abor arket contros. Aggregate cycica conditions are captured by a set of year effects. These year effects wi aso contro for changes in bargaining trends over tie. 21 Conditions in the industry and state abor arkets are proxied by a set of epoyent trends and residuas. We fit regression odes to the BLS quartery industry and state-eve epoyent series for the period We aow for quadratic trends, quartery seasona effects, and autoregressive error ters. n Eit = β + β t + β t i0 U it i1 i2 = φ(l)u 2 it j=1 + ε it δ ij Q, j +U it where n E it is og quartery epoyent in industry/state i at tie t; Q j is an indicator variabe for 20 The fir s assets is taken fro ite # 6, whie net incoe variabe is ite #172 in Copustat. 21 For exape, strike incidence has decined by roughy 50% over this twenty-five year period. 15

18 the j th quarter; φ(l) is an up to a second-order distributed ag poynoia; and ε it is a white noise error ter. We easure the tightness in the reevant abor arket using the estiated quartery epoyent residua, U it. We aso incude the estiated current epoyent growth rate (β i1 +2 β i2 t) as a easure of onger-ter perforance in the industry or state. 22 For those bargaining units that adopt an ESOP, we incude a pre- and post-adoption indicator in the specification. We easure the ipact of ESOPs on bargaining outcoes by taking the difference between the pre- and post-adoption coefficient estiates. This approach does not constrain the bargaining units that adopt ESOPs to have had siiar bargaining histories as the non-adopting bargaining units prior to putting the ESOP in pace. Before discussing the estiates of the ipact of ESOPs on bargaining outcoes, we wi briefy suarize the findings for the other contro variabes in Tabe 3. We find that the incidence of strikes as we as the fraction of abor disputes invoving a strike decine with fir size. Controing for the size of the fir, we find no effect of the size of the bargaining unit on any of the bargaining outcoe easures. The ikeihood of a strike increases with a fir s profitabiity as easured by the fir s net incoe. Controing for the fir s profitabiity, strikes are ore ikey in industries and states that are experiencing increasing trend epoyent growth. The overa ipact of ESOPs on strikes is given in specification (1) of Tabe 3. The data indicate that bargaining units that are associated with firs that adopt ESOPs were no ore ikey to experience a strike in the pre-adoption period reative to bargaining units at firs that never adopt an ESOP. Foowing the adoption of an ESOP, the strike incidence for adopting bargaining units decines by 6.2 percentage points. Specification (2) suggests that ESOP bargaining units experienced on average a 2.8 percentage point ower dispute rate prior to the adoption of the ESOP. Foowing the estabishent of the ESOP, these sae bargaining units experienced ony a sight decine in their dispute rate. Finay, as indicated in specification (3), prior to the adoption of an ESOP bargaining units that adopted an ESOP experienced a 1.6 percentage point higher fraction of disputes invoving a strike as did bargaining units that never adopted an ESOP. Foowing the estabishent of the ESOP, the fraction of disputes that 22 We aso contro for 2-digit industry effects as we as state effects. This ipies that the industry and state trend epoyent effects are identified off of the tie-varying coponent of the epoyent trends, β i2. 16

19 invoved a strike decined by 13.7 percentage points. This represents a 51 percent decine in the overa fraction of disputes taking the for of a strike. Tabe 4 copares the average ipact of ESOP adoption based on the theoretica benchark ode fro section 3 with the epirica ipact estiated fro Tabe 3. The estiated ipacts of ESOPs on strike and dispute incidence and dispute coposition ine up we with the caibration resuts based on the theoretica ode. 23 The caibrated ode indicates that the dispute rate shoud ony sighty fa (0.2 percentage points) in the post-esop period, whie the strike incidence shoud decine by neary 50 percent. The estiates reported in Tabe 3 indicate no significant change in the dispute rate and a reduction in the strike incidence that virtuay atches the caibrated estiate. Finay, the caibrated ode indicated that the fraction of disputes that invove a strike shoud decine by neary 11 percentage points. The epirica resuts find the fraction of disputes invoving a strike foowing the adoption of an ESOP faing by sighty over 15 percentage points. Both the caibrated ode and the epirica resuts indicate a arge shift in the coposition of abor disputes away fro costy strikes foowing the adoption of an ESOP pan. 5. Sharehoder and Labor Weath Effects In this section, we anayze the sharehoder weath associated with the announceent of an ESOP adoption. Whie the arket reaction to an announceent of a new ESOP has been docuented in the iterature, we provide new evidence on the announceent gains/osses disaggregated by the coective bargaining status of the fir. If ESOPs iprove the efficiency of contract negotiations and if these efficiency gains are shared between the union and the fir, then we woud expect to see these gains to the sharehoders capitaized into the announceent effect of a union ESOP. We easure these announceent effects using an event-tie ethodoogy as described in MacKinay (1997). We cacuate cuuative abnora returns (CAR) over three intervas around the announceent date of ESOP. We aso noraize the gain or oss by the nuber of epoyees to find out the average gain/oss to each worker The estiated argina effects of ESOPs on dispute incidence, strike incidence and dispute coposition are a insignificanty different fro the caibrated argina effects. 24 We take the nuber of epoyees for the year of ESOP adoption for each fir as reported by the Standard & Poor s Copustat database. It shoud be noted that the resuts reported here do not change if we choose the 17

20 Tabe 5 provides descriptive statistics on the firs in our overa (union and non-union) ESOP sape where we know the exact date of the ESOP adoption. 25 We report inforation on fir size (easured by the book vaue of assets and epoyent), growth opportunities (easured by arket to book ratio), and the size of the ESOP as a percentage of shares outstanding. Our sape of ESOP firs on average has neary $5.0 biion in assets. Unionized firs, with an average size of $10.6 biion are about 3.4 ties arger than the non-unionized firs. An average fir in our ESOP sape has about 21,000 epoyees. The unionized firs have workforces that are doube the size of the non-unionized firs. Firs that adopt an ESOP have a ean (edian) arket to book of 1.3 (1.2), indicating growth prospects. Unionized firs have a sighty higher arket to book than non-unionized firs. ESOPs on average have 11.6% of the fir's shares outstanding, with a edian equity stake of 8.0%. Appendix B provides inforation on the nae of the copany, the year of ESOP adoption and percentage shares outstanding in the pan for our sape of union ESOPs. Tabe 6 reports the event study resuts. We report CARs for three event windows (-5,5), (-5,1), and (-2,1), where t = -1 is the ESOP announceent date, and t = 0 is the date the announceent is reported in the press. For two of the event windows, we incude the five days prior to the press reease to capture any eakage of the news to the arkets, athough itte is reported in the iterature as to when the fir, if at a, shares the inforation with its epoyees about the ESOP. CARs for the overa sape of firs are positive and statisticay significant over each of the three intervas. The eeven-day CAR (-5, 5) and the seven-day CAR (-5,1) are 1.6% and 1.5% respectivey, whie the four-day CAR (-2,1) is 1.3%. Since our sape is different than those in other studies, we copare the announceent returns with findings in three other papers. Our cacuated four-day return of 1.3%, is a bit higher than that of Beatty (1995) and Chang and Mayers (1992), but is uch ower than Chang (1990) as reported beow. These studies differ because of the type of ESOPs incuded in the sape. Beatty points out that Chang's reported excess return of 3.7% woud be reduced to 1.6% if the 35 nuber of epoyees in the year before the year of ESOP adoption. The daiy returns used in our study are coected fro the Center for Research in Security Prices. 25 The ESOP sape decines fro 602 to 147 when we restrict ourseves to ESOPs where we know the announceent date. This dating inforation is iportant for conducting an event study of the stock arket reaction to the announceent of the ESOP. 18

21 everaged buyout ESOPs were excuded fro his sape. Thus, our announceent return is roughy coparabe to other studies. Study Sape Size Sape Period CARs Beatty (1995) Chang (1990) Chang and Mayers (1992) % 3.7% 0.7% Tabe 6 aso reports CARs disaggregated by the union status of the fir. For the 120 nonunionized firs, the CARs are sighty saer for the overa sape of firs. The CARs for the 27 unionized firs are around fifty percent arger than for the nonunion sape. For the unionized firs, the CARs are 2.4% for the interva (-5,5), 2.3% for the interva (-5,1), and 1.7% for the interva (-2,1). Whatever the benefits are to firs in genera fro estabishing an ESOP, the benefits are consideraby arger for unionized firs. To our knowedge, this feature of the data has not been previousy noted in the iterature. The caibration resuts dispayed in Figure 4 offer soe insights into this finding. The costs to current sharehoders of the fir giving epoyees an equity stake are the sae regardess of the union status of the fir. Union and nonunion firs ikey benefit equay fro the tax advantages afforded by estabishing an ESOP. If there are iportant productivity effects associated with ESOPs, it is ess cear that they woud be equay shared by non-union and union firs. However, the caibration exercise ceary iustrates that the expected bargaining osses associated with abor disputes decines with the size of the union s equity stake. This creates a differentia vaue of an ESOP to union firs which if understood by investors shoud be capitaized in the announceent effect. 6. Concusion Firs and unions that repeatedy negotiate abor contracts have an incentive to adopt fors of copensation that iniize the renegotiation costs. The adoption of uti-year contracts with prespecified deferred payents and a cost-of-iving cause is one exape. By extending the contract duration the costs of renegotiation can be aortized over a onger tie period. Siiary, ESOPs ay ater the incentives of the fir and union in ways that hep to 19

22 iniize the frequency and costs of abor disputes. Given the growth of ESOPs for unionized firs, the ipact of ESOPs on the coective bargaining process is an iportant area of research. In this paper, we argue that ESOPs ay ead to fewer strikes as a fraction of tota disputes. The presence of an ESOP changes the incentives of the union since it no onger coects its rents excusivey through the negotiated wage. We exaine the ipact of ESOPs on coective bargaining outcoes by extending the signaing ode of Craton and Tracy (1992) to aow the union to hod an equity stake in the fir. The ode predicts that increasing the size of the union's equity stake acts to ore cosey aign the union's interests with the interests of the fir. A consequence is a reduction in abor disputes and a shift by the union away fro the ore costy strike threat and towards the hodout threat. Using data on ajor coective bargaining negotiations fro , we find evidence consistent with the prediction that ESOPs (at east in the short run) reduce the overa incidence of strikes and shift the coposition of abor disputes towards hodouts. In subsequent negotiations their fraction of abor disputes that invove a strike fas beow the average for nonadopting bargaining units. The estiated agnitudes of the decine in strike incidence and the decine in the fraction of abor disputes that invove a strike atch up we to the caibrated estiates fro the ode. The theory suggests that sharehoders of unionized firs shoud experience a differentia gain fro the adoption of an ESOP. We verify this by conducting an event study of the stock arket reaction to ESOP adoptions. We find that the stock arket reaction to a unionized ESOP adoption is 50% arger than for a non-union ESOP adoption. These findings indicate that ESOPs ay provide firs and unions with a too to iprove the efficiency with which they renegotiate abor agreeents. Our anaysis appies ore generay to settings of cross ownership. Like ESOPs, cross ownership shoud reduce bargaining costs and ake coaborations ore productive. 20