1. Labor Representation in Governance as an Insurance Mechanism E. Han Kim, Ernst Maug and Christoph Schneider Presentation at the Ackerman Conference on Corporate Governance Bar-Ilan University, 17.12.2012

2. Motivation Question: What is the impact of labor representation on boards  on employment  on wages  on economic efficiency? Contrasting views  Efficient contracting: Labor representation supports efficient insurance contracts  Workers receive insurance in exchange for lower wages (e.g., Baily (1974), Harris & Holmstrom (1982), Holmstrom (1983))  Labor representation prevents ex-post expropriation  Rent seeking: Labor representation protects rents of workers and managers  Jensen & Meckling (1979), Pagano & Volpin (2005), Cronqvist et al. (2009)

3. Views on Labor Representation “The campaigns for ‘worker participation’ or ‘industrial democracy’ or codetermination on boards of directors appear to be attempts to control the wealth of stockholders' specialized assets … a wealth confiscation scheme.” (Alchian, 1984) The Chicago view: The European view: “Allen and Gale (2002) argue that in incomplete, imperfect markets, a stakeholder system of corporate governance that stresses cooperation between management and employees may allocate resources more efficiently in the long run than a shareholder system.” (Fauver and Fuerst, 2006, p. 674)

4. World Map of Labor Representation on Boards

5. Institutional background Codetermination in Germany  Up to 500 employees in Germany:  no worker representation  More than 500 up to 2000 employees in Germany:  1/3 of the board members have to be worker representatives  Board size between 3 and 21 can be chosen (multiple of 3)  More than 2000 employees in Germany:  1/2 of the board members have to be worker representatives  Casting vote of the chairman (shareholder representative)  Board size 12, 16 or 20 (cutoff:s 10,000 and 20,000 employees)  Exception in the iron, coal, and steel industry: one neutral member in firms with more than 1000 employees (board size: 11, 15, 21)

6. Codetermination in Germany (since 1976)

7. Research questions What is the impact of parity codetermination on  employment: do parity-codetermined firms provide more insurance to workers against adverse shocks?  wages: to the extent that the workers in parity-codetermined firms recieve insurance, do they pay an insurance premium?  firm risk: are parity-codetermined firms more risky because they provide insurance to their workers?

8. Sample  184 large listed German corporations (1990-2009)  All DAX and MDAX companies  Most publicly available information (governance, stock market, balance sheet, and P&L data)  IAB sample of all German businesses (1975-2008)  Detailed establishment level data on industry, location, employment, wages, education, age, (nationality)  In total approx. 33.4 million establishment-year observations for period 1990-2008  34,000 establishments matched to 142 of our 184 firms  Matching on company and subsidiary names and addresses for the year 2006 (2004, 2005)

9. Research design  Compare how negative shocks affect employees and  firms with parity codetermination vs.  firms with less or no representation on the board  Difference-in-difference model:  i indexes establishments  j indexes firms  k indexes state of location  l indexes industry  t indexes time

10. Definition of shocks  Shock needs to be  large enough to have a significant impact  frequent enough to permit identification  exogenous to the firm  We use non-sample firms with establishments in Germany (IAB employment data)  Based on >30 million establishment-years  Industry defined as 3-digit NACE (subsector), similar to NAICS  Shock lt = 1 in industry l if employment in the industry decreases by at least 5%  Shock lt = 1 in industry l only if employment growth ≤ 0 in year t+1 (persistence)

11. Shocks: Examples  Shocks can be long-lived:  2-year shocks: Shock lt+1 = 1 if Shock lt = 1 and employment growth ≤ 0 in year t+1  4-year shocks: Shock lt+j = 1 if Shock lt = 1 and employment growth ≤ 0 in year t+j for j=1, 2, 3  baseline case

12. Distribution of shocks across time

13. Parity codetermination is a commitment device. With parity codetermination, workers receive full insurance against adverse shocks to employment. Hypothesis 1

14. Do parity firms protect their employees?

15. Employment changes after adverse industry shocks All employees

16. Do parity firms protect their employees? Employment changes after adverse industry shocks All employeesWhite collar

17. Do parity firms protect their employees? Employment changes after adverse industry shocks All employeesWhite collarBlue collar

18. Do parity firms protect their employees? Employment changes after adverse industry shocks All employeesWhite collarBlue collar Unskilled blue collar

19. Firms with parity codetermination pay on average lower wages. Hypothesis 2

20. Do employees pay an insurance premium?

21. Difference in median wages - parity vs. non-parity firms Highly qualified employees Skilled employees Unskilled employees

22. Is there any wage compression?

23. Parity-codetermined firms suffer larger reductions of profitability after adverse shocks than non-parity firms. Hypothesis 3

24. Performance of codetermined firms (1)

25. Performance of codetermined firms (2)

26. Performance of codetermined firms (3)

27. Conclusion  Employees of parity-codetermined firms receive substantially more employment insurance  Only skilled blue-collar and white-collar workers benefit  Unskilled workers receive no protection  Only highly-qualified employees pay an insurance premium  Skilled blue-collar employees enjoy insurance without paying a premium  Parity-codetermined firms have significantly larger operating leverage  Larger declines in ROA and Tobin‘s q, increase in CAPM beta