Co Corporate Lever erage and Corporate Leverage and Employees’ Rights in Bankruptcy Em Employees’ Rig ights in in Bankruptcy Marco Pagano University of Naples Federico II, CSEF, EIEF & ECGI Andrew Ellul Indiana University, CSEF, CEPR & ECGI Stockholm, 10 June 2016 Global Corporate Governance Colloquia
Mo Motivation � Conflict between labor and capital (shareholders, creditors) over the surplus S produced by the firm Corporate Leverage and Employees’ Rights in Bankruptcy For a start, take an all-equity firm with revenue R � � If W 0 is the reservation wage, and the labor force is standardized to 1, the firm’s surplus is With Nash bargaining and union’s bargaining power α , the � wage is: ( ) = + α − W W R W 0 0 2
Strategic Val St alue of Leverage � With debt, surplus S is divided in th three cash flows: • shareholders (residual claimants) Corporate Leverage and Employees’ Rights in Bankruptcy • creditors • workers � If the firm issues debt D and pays its value V D to shareholders before bargaining with unions, it reduces the surplus S on the bargaining table ⇒ reduces the wage: ( ) = + α − − W W R W D 0 0 ⇒ the greater unions’ power, the greater debt’s strategic value: Baldwin (1983), Bronars & Deere (1991), Perotti and Spier (1993), Matsa (2010), etc. 3
Key Ta Ke Tacit As Assumptions So Far � All previous work in this area ta tacitly assumes that 1. employees’ claim to unpaid wages, severance pay and social Corporate Leverage and Employees’ Rights in Bankruptcy security contributions are ju junior to other debt in bankruptcy liquidation procedures: otherwise their claim could not be diluted by issuing debt (at least not entirely) 2. workers ca canno nnot rene negotiate this claim with creditors if the firm is restructured rather than liquidated: again, if they have any bargaining power in such ex post renegotiation, their claim would not be diluted by ex ante debt issuances � Yet these assumptions are no not universally true: the legal standing of employees in bankruptcy differs a lot across countries. This is the starting point of our work 4
Employee Seniority Em ty in a Strategic Debt t Model Time line: stage 5 solvency: Corporate Leverage and Employees’ Rights in Bankruptcy (i) creditors are fully repaid, (ii) workers are stage 1 stage 2 stage 3 stage 4 paid the agreed wage W , (iii) shareholders debt D workers hired revenue receive profits is are hired, workers R is chosen expecting (re)negotiate realized insolvency: E( W ) ≥ W 0 wage W (i) bankruptcy costs C are paid, (ii) workers and creditors split R+A based on seniority 5
Ke Key Assumptions � All players are risk neutral, with no discounting Corporate Leverage and Employees’ Rights in Bankruptcy � At wage bargaining stage ( t = 3), negotiation occurs via take-it- or-leave-it offers, according to the random proposer model: with prob. α union sets set W = W u , with prob. 1 − α firm sets W = W f � At final stage ( t = 4), when creditors and workers are to be paid, • in solvency states, workers are paid the agreed wage W • in default states, workers are senior to other creditors for a fraction θ of the wage, junior for fraction 1– θ 6
Re Revenue, Wages and Bankruptcy � � � Revenue is uniformly distributed: ⇒ = R ~ U (0, R ) E R ( ) R / 2 � − > � Production is efficient: E R ( ) W 0 Corporate Leverage and Employees’ Rights in Bankruptcy 0 � Bankruptcy occurs if , and entails cost C � The firm sets W f so that in expectation it equals W 0 ⇒ just meets the workers’ participation constraint (PC) � The union sets W u so as to maximize the expected income of employees, in both solvency and bankruptcy states 7
Wo Workers’ Income with Union-se set Wage e ( W u ) workers’ income Corporate Leverage and Employees’ Rights in Bankruptcy � Y u Insolvency region Solvency region W u θ W u 0 + θ + θ A D W W D W firm’s + A R u u u resources � � ≡ + X A R 8
Re Response of Leverage to Changes in the Va Value of Assets or Expected Revenue � Optimal leverage will balance debt’s strategic value with the expected bankruptcy costs Corporate Leverage and Employees’ Rights in Bankruptcy � If θ < 1, the firm will raise its debt more in response to increases in A and in E(R) if 1. workers’ seniority ( θ ) is high 2. union power ( α ) is high � Intuition: • If the available surplus increases, workers bargain more aggressively for a share of it if they have high seniority or unions are strong • the firm wants to issue more debt in response to the increase in surplus if it is in a country where workers have high seniority or unions are strong 9
Al Allowing for Debt Renegotiation � In the baseline model, in bankruptcy creditors are assumed to simply cash the firm’s value, net of bankruptcy costs C and of Corporate Leverage and Employees’ Rights in Bankruptcy the senior portion of workers’ wages θ W � But if creditors are not dispersed, they have the incentive to restructure the firm, avoiding the bankruptcy cost C � To do so, they may have to renegotiate with workers: the split of the bankruptcy cost saving will depend on the workers’ bargaining power β at renegotiation stage � Higher β ⇒ workers expected to take more surplus from creditors in bankruptcy ⇒ lower firm’s debt capacity ⇒ lower debt (while α raises debt issuance for strategic reasons) 10
Pu Public Insurance of of Employees of of Default lted Co Companies � Suppose employees have no seniority but are protected by public insurance: they receive a fraction γ of the agreed Corporate Leverage and Employees’ Rights in Bankruptcy salary W in bankruptcy states � Then the optimal salary set by the union is increasing in γ � Additional motive to issue strategic debt: the optimal debt level is increasing in insured fraction γ and in union power α , consistently with Agrawal and Matsa (2010) � Moreover, the sensitivity of optimal debt to the firm’s expected revenue is increasing in the insured fraction γ of the wage: again, important for our empirical tests 11
Testable Predictions of the Strategic Debt Te Mo Model � Focus on predictions of this model concerning the se sensitivity of leverage to le o the fir irm’s s asse sset value and/or revenue (relevant for Corporate Leverage and Employees’ Rights in Bankruptcy our empirical strategy) � This sensitivity is lar larger when employees have: stronger seniority rights θ • st greater bargaining power α in • gr in wage negotia iations ining power β in • lo lower bar argain in fir irm restructurin ing nsurance γ in bankruptcy • be better r publ public c ins � How specific are these predictions to the strategic debt model? To answer this question, we consider an alternative model… 12
Al Alternati tive Model: : No Non-Str Strategic Debt t Is Issuance by by Con onstrain ained Firms � Suppose that debt is issued: after wage bargaining ⇒ cannot be used strategically • af Corporate Leverage and Employees’ Rights in Bankruptcy • to fund a profitable and scalable investment whose revenue cannot be pledged ⇒ firm can pledge on only existing assets A an and re revenue R to fund it � The firm invests all the money it can raise = choose the face value of debt D to maximize the market value of debt V D � In this situation, higher employee seniority and/or bargaining power lowers the firm’s debt capacity � So higher θ and α lower the response of D to changes in asset value or revenue: op opposite to strategic debt mod odel! 13
Wo Workers’ Pr Protection in Bankruptcy around th the World � There is considerable cross-country variation in • workers’ seniority in bankruptcy law ( θ ) Corporate Leverage and Employees’ Rights in Bankruptcy • protection of their rights in reorganization procedures ( β ) • government guarantees ( γ ) � We collect data on these items via • questionnaires to Lex Mundi law firms (mainly for OECD countries) • information drawn from the web (mainly for non-OECD countries) � Important: these indicators have low correlation with EPL, which we use as a proxy of union power α (as done by Simintzi et al., 2015) 14
ng θ : Measuring Me : Wo Worker Sen eniority in in Bankruptcy Ba � Worker seniority in liquidation differs across countries � We looked at the rank of workers’ claims relative to the Corporate Leverage and Employees’ Rights in Bankruptcy following claim classes: • secured debt (e.g. real estate mortgage loans) • expenses of the bankruptcy procedure • post-petition credit extended to debtor • unpaid taxes • unsecured debt � Define workers’ seniority from 1 to 5, so that 1 = they are treated as unsecured creditors, 5 = they are the most senior 15
ng θ : Me Measuring : Wo Worker Sen eniority in in Ba Bankruptcy Significant cross-country variation in ranking of workers in the case of bankruptcy procedures: first in France, Mexico, Brazil, last in Finland and Germany Corporate Leverage and Employees’ Rights in Bankruptcy 16
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