




































INDIAN JOURNAL OF FINANCE AND BANKING 10(1) (2022), 1-11 

1 

 

                   FINANCE AND BANKING 

                                                                  IJFB VOL 10 NO 1 (2022) P-ISSN 2574-6081  E-ISSN 2574-609X 
                                                  

        Available online at https://www.cribfb.com 
                                                                                                                                           Journal homepage: https://www.cribfb.com/journal/index.php/ijfb 

                                                                                                                                                                                                   Published by CRIBFB, USA 

THE GOVERNANCE ROLE OF LABOR UNIONS IN IMPROVING 

INVESTMENT EFFICIENCY                                                          

 
 Yong-Chul Shin (a)   Surjit Tinaikar (b)1   Yu Zhang (c) 

 

(a) Ph.D., Associate Professor, College of Management, University of Massachusetts Boston, Boston, U.S.A.; E-mail: yong-chul.shin@umb.edu 
(b) Ph.D., Associate Professor, College of Management, University of Massachusetts Boston, Boston, U.S.A.; E-mail: surjit.tinaikar@umb.edu 
(c) Ernst & Young, U.S.A.; E-mail: yu.zhang0326@gmail.com 

 

 
A R T I C L E I N F O 

 
 

Article History: 
 

Received: 14th March 2022  
Accepted: 24th April 2022 

Online Publication: 27th April 2022 

 
Keywords: 
 

Corporate Governance  

Investment Efficiency 

Labor Union  

 

 
JEL Classification Codes: 

 

J51, J59, O16, G31 

 

  
 

 
A B S T R A C T 

 
We focus on the role that labor unions can play in influencing firms’ efficiency in corporate investment 
decisions where investment efficiency is defined as the extent to which deviations from optimal 

investment levels are minimized. We argue that unions may not simply be adversaries of managements 

as is often believed but have incentives to monitor managements in ways similar to that of other 

corporate governance players. These incentives stem from the fact that unions, like other corporate 

stakeholders, are adversely affected by investment inefficiencies that may result from firm-level 

overinvestment and underinvestment decisions. Consistent with this explanation, we find that labor 

unionization is indeed positively associated with improvements in investment efficiency and that these 

effects are generally stronger in bargaining environments that are favorable to unions. For instance, 
union effects in improving investment efficiencies are stronger in states where the Democratic Party is 

more influential and in states which have not enacted legislations that restrict union activities. These 

results indicate that union monitoring of investment efficiency is more likely to occur through channels 

that are a part of unions’ collective bargaining processes. Our results are robust to different measures 

of investment efficiency, different empirical specifications, and endogeneity of union membership. 

 
 

© 2022 by the authors. Licensee CRIBFB, USA. This article is an open access article  distributed 
under the terms and conditions of the Creative Commons Attribution (CC BY) license 
(http://creativecommons.org/licenses/by/4.0/).  

 
                                                     

 

INTRODUCTION 

This study examines the governance role that labor unions can play in guiding a firm’s investment expenditures in physical 

capital and R&D towards more optimal levels. Deviations from these optimal levels are seen as inefficient investment 

decisions that may cause firms to overinvest in negative net present value (NPV) projects or underinvest in positive NPV 

projects.  

It is widely held in the neo-classical economy that corporate investment is a function of marginal Q (Abel, 1983). 

Firms generally invest until the marginal benefit of capital equals the marginal cost. However, imperfections due to the 

information asymmetry may cause firms to deviate from optimal capital investment policy (Jensen, 1986; Stiglitz & Weiss, 

1981). Prior literature has explored several factors that can mitigate these agency problems and thereby improve investment 

efficiency. For example, an effective corporate governance system that encompasses managerial incentives and optimal 

organization of external resources could minimize problems relating to sub-optimal investment decisions. Firm-level 

corporate governance structures in the form of managerial ownership, institutional holdings, equity-linked compensation 

and board independence could reinforce managerial incentives to make optimal investment decisions. We extend this line 

of literature by examining the monitoring of investment efficiency that is associated with yet another important corporate 

governance institution - labor unions. 

Labor unions, as representatives of workers constitute an important stakeholder group and are increasingly 

assuming the role of insiders. Unlike shareholders and institutional owners who can reduce the risk associated with a firm’s 

bad performance by holding a diversified portfolio, employees are unlikely to be able to diversify their earnings from the 

firm (Amihud & Lev, 1981).  This makes employee welfare even more dependent on the firm value which in turn makes 

employee incentives to monitor the firm’s capital investment policy even more important than in the case of shareholders.  

                                                      
1Corresponding author: ORCID ID: 0000-0003-2654-0366 

© 2022 by the authors. Hosting by CRIBFB. Peer review under responsibility of CRIBFB, USA.  

https://doi.org/10.46281/ijfb.v10i1.1698 
 

To cite this article: Shin, Y.-C., Tinaikar, S., & Zhang, Y. (2022). THE GOVERNANCE ROLE OF LABOR UNIONS IN IMPROVING INVESTMENT 

EFFICIENCY. Indian Journal of Finance and Banking, 10(1), 1-11. https://doi.org/10.46281/ijfb.v10i1.1698 

http://creativecommons.org/licenses/by/4.0/)
http://creativecommons.org/licenses/by/4.0/)
https://doi.org/10.46281/ijfb.v10i1.1698
https://doi.org/10.46281/ijfb.v10i1.1698
https://orcid.org/0000-0002-0832-0696
https://orcid.org/0000-0003-2654-0366
https://orcid.org/0000-0003-0024-4569


Shin et al., Indian Journal of Finance and Banking 10(1) (2022), 1-11 

 

2 

Workers and unions could impact corporate investment decisions directly by securing board representation through equity 

ownership or indirectly by engaging in disruptive activities such as strikes and political lobbying (Chen, Kacperczyk, & 

Ortiz-Molina, 2011). The focus on unionization therefore allows us to examine an important channel through which 

investment projects may be monitored viz. the collective bargaining process. This is a relatively unexplored area in the 

literature examining corporate governance structures and their role in contributing to investment efficiency.  

The governance role of labor unions has often been understated in prior literature. Yet unions have the potential to 

contribute positively to firm performance by facilitating a cooperative labor relations environment (Freeman & Medoff, 

1979), monitoring contracts between management and shareholders (Jensen, 2010; Banning & Chiles, 2007) and inducing 

better financial reporting practices by demanding higher quality audits and internal control systems (Chung, Cho, Lee, & 

Son, 2017). We envisage that labor unions can play a similar constructive role in nudging managements towards making 

more efficient investment decisions. Prior literature in this area has generally documented a decline in investment in physical 

capital and R&D in unionized firms. In the union rent-seeking framework of Hirsch (1991), firms respond to the increased 

wage premiums by reducing investment levels. However, not all reduction of investment expenditures can be seen as 

evidence of union rent-seeking. If managers overinvest solely with the purpose of consuming perquisites and growing the 

firm beyond the optimal size (Jensen, 1986), then a decline in such investments in unionized firms could reflect a monitoring 

effect of labor unions rather than a rent-seeking one.  

When it comes to managerial underinvestment, there is an intuitive explanation for unions to possess incentives in 

limiting underinvestment.  Unions acting on behalf of employees have much at stake if the underinvestment problem 

becomes severe particularly during times of structural change and economic and social upheaval. Unions’ demand for higher 

wages can end up being redundant if companies are not resourceful enough to work out the higher labor costs. The Textile 

Workers’ Union of America (TWUA) often encouraged companies to modernize and invest even though such measures 

often ended up eliminating jobs. Aware that underinvestment was often an early warning signal of eventual liquidation, the 

TWUA sought to preserve a number of high paying positions by coupling wages with corporate investment policy (Hartford, 

1996). Union leader Jimmy Settles once said to the press, "When they invest in plants, plants stay open” (Priddle & Snavely, 

2015). Unions thus have an incentive in ensuring that managements do not underinvest in assets that may threaten future 

employee job security and consequently unions’ own survival and relevance in labor markets. 

Using a large sample of 3,658 firms over a period of thirty-one years, we document that firms in industries that are 

unionized are less likely to overinvest or underinvest in physical assets and R&D. To measure investment efficiency, we 

rely on the overinvestment and underinvestment measures discussed in Biddle, Hilary, and Verdi (2009). We are aware that 

any test of unionization effects on over- or underinvestment is a joint test of the union effects as well as the appropriateness 

of the model that defines “optimal” investment. Hence, we also conduct our primary empirical analyses using alternative 

investment efficiency measures such as those discussed in Richardson (2006) and continue to obtain similar results. Our 

results are also robust to inclusion of several firm-level characteristics and endogeneity of union membership.  

We also study the cross-sectional variation in investment efficiency that may arise from differences in the quality 

of the bargaining environment. Our focus on the bargaining environment is for the following reason. If the positive 

association between unionization and investment efficiency is not driven by the monitoring role of unions exercised as a 

part of bargaining, then we should find no observable differences in this relationship when the bargaining environment is 

allowed to differ. It is not obvious why the positive union effects on investment efficiency would be systematically higher 

in situations where unions have an advantage in bargaining. Stronger union effects on investment efficiency in settings 

where unions have greater bargaining power would thus strengthen our hypothesis of unions assuming a monitoring role 

during the collective bargaining process. Consistent with this explanation, we find that the positive union effects on firms’ 

investment efficiency are generally stronger in states where the political party to which unions are affiliated viz. the 

Democratic Party is more influential and weaker in states which have enacted legislations that make it harder for unions to 

acquire new members. (Note 1) Our results are also largely unchanged even when we decompose investments into physical 

capital investments (Capex) and R&D. (Note 2) 

This study contributes to the literature in at least two ways. First, using a large sample of 3,658 firms we discover 

an important governance institution that may influence corporate investment efficiency viz. labor unions. Second, we find 

that union monitoring of managerial overinvestment is more likely to occur as a part of unions’ collective bargaining 

processes. This is evidenced by the stronger union effects on investment efficiency observed in environments where unions 

have greater bargaining power. 
 

RELATED LITERATURE AND HYPOTHESES DEVELOPMENT 

A number of studies have examined the role of labor unions in influencing corporate strategic decisions. For instance, Denny 

and Nickell (1991) and Bradley, Kim, and Tian (2017) find that unionized firms invest less in innovation related R&D in 

an attempt to offset union rent-seeking.  Others have examined how unionization can induce firms to increase information 

asymmetry (Hilary, 2006), reduce CEO compensation (Banning & Chiles, 2007) and reduce strategic cash holdings (Klasa, 

Maxwell, & Ortiz-Molina, 2009). Our development of the hypotheses below is in line with these studies.  

 

Relationship between Overinvestment and Unionization 

Examining the relationship between union strength and managerial incentives to overinvest necessitates an understanding 

of the two competing views in the labor economics literature about union effects on investment. Hirsch (1991) contrasts 

these two views in his book. The traditional view argues that unions’ ability to raise wages above competitive levels causes 

firms to move up along the labor demand curve. Investment in capital or innovation then depends on scale and substitution 

effects that work in opposing directions.  Hence this view argues that the net effect of unionization on investment is thus 



Shin et al., Indian Journal of Finance and Banking 10(1) (2022), 1-11 

 

3 

unclear. The union rent-seeking view hypothesizes that firms reduce investment to levels similar to those firms with a 

nonunion labor force. These models posit that unions divert some of the firm’s quasi-rents from capital to themselves.  This 

in turn reduces the incentives of firms to invest. More formal models of the union rent-seeking view are described in Baldwin 

(1983) among others. Empirical studies have generally documented results that are consistent with the union rent-seeking 

view (Bronars & Deere, 1993). 

However, to assume that unions always play an adversarial role with respect to the interests of the firm in its choice 

of investment projects may be an incomplete characterization of the problem. A labor union can be a key player in 

maintaining a system of checks and balances within the governance structure relating to monitoring overinvestment. 

Managers consider the firm a source of extracting private benefits (Jensen & Meckling, 1976) and increasing their own 

human capital (Zingales, 1998). Hence, managers sometimes make investment decisions that may not be purely value-

maximizing. For example, when profitable investment opportunities are limited, managers may prefer to use excess free 

cash flows for opportunistic reasons (Jensen, 1986). These activities ultimately result in an increase in firm size, but not 

firm value.  

A dilution in firm value hurts all other stakeholders, including employee unions. Unions are hurt because diversion 

of corporate resources away from unionized members to those who run the corporation reduces the magnitude of rents 

available for unions to negotiate and capture during collective bargaining. In effect, overinvestment has the consequence of 

diluting the unions’ bargaining power vis-à-vis the firm. Furthermore, overinvestment of free cash flows takes away valuable 

funds that could be used to finance growth options that may arise in the future. Lack of financing options during these times 

could then lead firms to a state of underinvestment (Opler, Pinkowitz, Stulz, & Williamson, 1999) thereby leading to an 

increased probability of liquidation and bankruptcy. Unions therefore have incentives to monitor managerial 

overinvestment.  The monitoring may happen through several channels – by making wage demands that affect managerial 

flexibility to choose projects, by organizing protests or strikes that may delay new investment plans, through threats to use 

political connections which in turn can create uncertainties for new plans or through more aggressive posturing in give-and-

take during collective bargaining negotiations. 

Based on the set of arguments described above, we state our first hypothesis in alternate form as follows: 

H1: Unionization is positively associated with investment efficiency that results from mitigating 

overinvestment problems.  

 

Relationship between Underinvestment and Unionization 

The implications of unionization for underinvestment can be understood in context of theories developed to understand debt 

holders and shareholder conflicts. Stiglitz and Weiss (1981) show that debtholders can anticipate the opportunistic behavior 

of managers and shareholders and attempt to limit it by raising the cost of debt or by rationing credit. Consequently, a 

positive NPV investment opportunity ends up not being taken due to the high cost of debt. Because employee renumeration 

cash flow streams are similar to the payouts on risky debt (Chen, Kacperczyk, & Ortiz-Molina, 2012) underinvestment could 

occur if unions pressure firms to raise wages which may reduce shareholders’ incentives to invest in positive NPV projects. 

The union rent-seeking theories also predict similar outcomes. In these models, unions end up capturing a portion of the 

firm’s economic rents from capital thereby creating incentives for firms to underinvest. These theoretical arguments would 

imply that unionization exacerbates underinvestment problems.  

Yet anecdotal evidence abounds that unions have incentives to prevent underinvestment because underinvestment 

is often a precursor to bankruptcy and eventual loss of jobs. Unions therefore have to balance their demands for higher 

wages with concerns relating to continuation of future employment. The TWUA union often encouraged companies to 

modernize their plants in post-war America when the textile industry was seen as extremely unstable, even if it meant the 

elimination of some jobs. Hartford (1996) documents that union leaders faced the difficult problem of not only convincing 

mill owners to make much needed investments, but also persuading workers and union representatives that such economic 

modernization measures were in their own best long-term interests. Labor economist, Solomon Barkin has argued that 

workers do not approve of managements who neglect the company’s physical, competitive and financial capital (Hartford, 

1996).  The mega-billion dollar agreement between the United Automobile Workers (UAW) and Ford in November 2015 

has new investment in plants and products as its cornerstone. UAW Vice President Jimmy Settles in a statement to the press 

said "When they invest in plants, plants stay open”. Unions thus have an incentive in ensuring that managements do not 

underinvest in assets that may threaten future jobs. This seems to suggest that unions are not myopic and are concerned 

about management investment decisions that may erode the competitiveness and financial stability of the firm in the long 

run. Liberty and Zimmerman (1986) note that labor negotiations often take place every three years suggesting that unions 

care about long-term issues. 

Given the strong anecdotal evidence available, we propose the second hypothesis as: 

H2: Unionization is positively associated with investment efficiency that results from mitigating 

underinvestment problems.  

 

CROSS-SECTIONAL VARIATION IN INVESTMENT EFFICIENCY 

In this section we examine the cross-sectional variation in investment efficiency arising from differences in the quality of 

the bargaining environment. (Note 3) If the positive association between unionization and investment efficiency that we 

document in this study is unrelated to the governance role of unions, then we should find no observable difference in this 

relationship when the bargaining environment is allowed to differ.  It is not obvious why union effects on investment 

efficiency would be systematically higher in situations where unions have greater bargaining power. A more facilitative 

bargaining environment may allow unions to better exercise their governance role by having a more forceful say on corporate 



Shin et al., Indian Journal of Finance and Banking 10(1) (2022), 1-11 

 

4 

strategic investment plans through give-and-take during negotiations, through threats of strikes, and through threats to bring 

in legislation by using their political connections. Favorable bargaining environments may also spur unions in demanding 

better quality financial information from employers (Chung et al., 2017) which in turn may help unions to better assess 

investment plans and projects and detect managerial opportunistic behavior in investment decision-making. 

Right-to-Work (RTW) laws enacted in many states prohibit agreements between unions and employers and put 

restrictions on the extent to which employees can join unions. These restrictions can create free-rider problems for unions 

and dilute their bargaining power (Ellwood & Fine, 1987). Lower bargaining power implies that unions are unlikely to have 

a forceful say at the bargaining table or be able to garner enough financial resources to organize effective protests when 

managers take investment decisions that are unfavorable to the union. Thus, one would expect union effects of improving 

investment efficiency to be lower in states that have enacted RTW laws. The first part of the third hypothesis is thus stated 

in alternate form as: 

H3A: The positive association between unionization and investment efficiency is weaker in states that have 

enacted Right-to-Work legislation.  

 

Unions have also developed close ties with the Democratic Party ever since unions benefitted from the friendly 

labor policies of President Roosevelt in the 1930’s. Union members typically tend to vote Democratic Party candidates. 

Union leaders can threaten to use their political connections to bring in legislation unfavorable to employers or better use 

their political contacts to garner organizational resources in an attempt to prevent management opportunism or indifference 

in investment decision making. We therefore argue that unions tend to be more powerful and have greater bargaining power 

in states ruled by the Democratic Party. Thus, the positive union effects on investment efficiency may be stronger in states 

ruled by the Democratic Party. The second part of the third hypothesis is thus stated as:  

H3B: The positive association between unionization and investment efficiency is stronger in states that are 

ruled by the Democratic Party.  

 

RESEARCH DESIGN 

Measurement of Investment Efficiency (INVEFF) 

Biddle et al. (2009) employ a model of firm-level investment as a function of growth opportunities (as measured by lagged 

growth in Sales). The residuals are then interpreted as a firm-specific measure of unexplained investment. Their model of 

expected investment is described below as: 

𝐼𝑁𝑉𝐸𝑆𝑇𝑀𝐸𝑁𝑇𝑖,𝑡+1 =  𝛽0 + 𝛽1 ∗ 𝑆𝐴𝐿𝐸𝑆𝐺𝑅𝑂𝑊𝑇𝐻𝑖,𝑡 + 𝜀𝑖,𝑡+1                       (1) 

Equation (1) is estimated within each industry-year level using Fama-French 48-industry classification and with at least 20 

observations in each industry-year.  

Firm-years that are grouped in the lowest quartile (i.e., the most negative residuals) are classified as the 

underinvesting group while those in the highest quartile (i.e., the most positive residuals) are classified as the overinvesting 

group. Firm-years that are grouped in the middle two quartiles are classified as the benchmark group. We estimate a logistic 

model that predicts that a firm will be more likely to be in the benchmark group (INVEFF =1) as opposed to each of the 

extreme quartile (i.e., the underinvesting and overinvesting) groups (INVEFF =0). 

 

Measurement of Union Strength (UNION) 

Since firm-level unionization data is not required to be disclosed by U.S. firms, many large-sample U.S. prior studies of 

labor unions have relied on the unionization data from the industry-level union database that Hirsch and Macpherson 

constructed (see Hirsch & Macpherson, 2003) (e.g., Chen et al., 2011; Klasa et al., 2009; Chen et al., 2012). Some others 

have transformed the industry-level unionization rates into a firm-level measure by using the product of the unionization 

rate and the number of employees for each firm-year scaled by the book value of total assets (Hilary, 2006; Hamm, Jung, & 

Lee, 2018; Hsieh, Jung, & Yi, 2017). We adopt this approach for our study as we believe that this approach strikes a good 

balance between preserving the sample size and recognizing the fact that unionization is both a firm level and an industry-

level decision. We also perform our analyses by directly using the industry-level unionization rates. (Note 4) Our results 

continue to remain qualitatively unchanged. All empirical results are presented using the firm-level unionization measure.  

 

Empirical Models for Testing Unionization Effects on Investment Efficiency 

The primary logistic regression model to test the association between INVEFF and UNION is described below. 

𝐼𝑁𝑉𝐸𝐹𝐹𝑖𝑡 =  𝛼 + 𝛽1𝑈𝑁𝐼𝑂𝑁𝑖𝑡 + 𝑋𝑖𝑡
′ +  𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝐸𝑓𝑓𝑒𝑐𝑡𝑠 + 𝑌𝑒𝑎𝑟 𝐸𝑓𝑓𝑒𝑐𝑡𝑠 + 𝜀𝑖𝑡                (2) 

Where i indicates firm and t the year. 𝑋𝑖𝑡
′  is a vector of firm specific control variables that have been known to drive capital 

investment (Biddle & Hilary, 2006; Biddle et al., 2009; Richardson, 2006). 𝜀𝑖𝑡  is an error term. (Note 5) 

 

Endogeneity of Union Membership 

A potential econometric problem in our study could arise if firms choose to unionize based on unobserved factors that could 

be correlated with our measures of investment efficiency. This would make our UNION variable an endogenous variable 

that could confound our findings. We attempt to address this problem using an instrumental variables approach. We use 

three instruments to address endogeneity – state-level unemployment rates (UNEMPRATE), industry concentration (HHI), 

and old economy industry (OLDECON). Blanchflower, Crouchley, Estrin, and Oswald (1990) argue that when local 

unemployment rates are high, the penalty associated with being sacked would be higher due to fewer job opportunities, 

spurring more individuals to join unions. Employees in concentrated industries are also more likely to be unionized due to 



Shin et al., Indian Journal of Finance and Banking 10(1) (2022), 1-11 

 

5 

high expected benefits that can be captured in a firm facing less competition and lower coordination and organization costs. 

Industry concentration implies higher economic profits and unionism may provide a means of redistributing some portion 

of these profits to workers (Hirsch & Berger, 1984). Unionization is also more likely to occur in highly regulated 

environments as is often associated in “old economy” industries such as transportation, utilities and government, where 

entry is regulated and minimum prices are set by regulatory commissions. If profits are enforced through price regulation, 

individual firms may have fewer incentives to confront unions on wages, thereby encouraging unionization (Hendricks, 

1977).   

 

SAMPLE AND EMPIRICAL RESULTS 

Sample Selection 

Our initial sample for calculating the overinvestment and underinvestment residuals consists of all firm-year observations 

from the period 1974-2013. We then merge this data with the labor union coverage data which is first available from 1983. 

So our final sample includes observations from the period 1983-2013. We match industry-level union coverage data at the 

4-digit SIC level to each firm-year in COMPUSTAT North America. We exclude financial firms with SIC codes from 6000–

6999 because financial firms typically have different operating, investing, and financing activities from other firms in the 

economy. Our final sample after deleting missing observations for UNION, INVEFF and control variables consists of 23,475 

firm-years and 3,658 unique firms. 

 

Empirical Results 

Table 1 describes the characteristics of the sample. The mean (median) INVESTMENT for the firm is about 17% (10%) of 

total assets, while that for CAPEX is about 41% (22%) of a firm’s Property, Plant and Equipment. The median firm has total 

assets of around $88 million (Log of total assets i.e. LOGAT = 4.48). The average Market-to-Book ratio (MKTBOOK) for 

our sample is around 1.74, which means our sample is dominated by firms with relatively fewer growth opportunities. The 

median industry-level and firm-level unionization rates for the firms in our sample are around 10% and 7% respectively. 

Correlation statistics (not reported) also reveal that unionized firms typically tend to be older, more leveraged, have fewer 

growth opportunities, are less likely to be financial distressed or loss-making and show lesser firm-level uncertainty as 

evidenced in volatility of cash flows. This is consistent with the profile of unionized firms documented in prior literature 

(Liberty & Zimmerman, 1986).  

 

Table 1. Descriptive Statistics 

 
Variable Mean STD 25% Median 75% 

INVEFF 0.50 0.50 0.00 1.00 1.00 

INVESTMENT 16.71 32.85 4.87 10.28 19.79 

CAPEX 41.46 156.97 11.60 21.89 41.02 

NONCAPEX 8.89 24.11 0.00 1.87 9.91 

UNION 0.13 0.15 0.03 0.07 0.18 

LOGAT 4.63 2.19 2.89 4.48 6.25 

D/A 0.17 0.16 0.02 0.14 0.29 

MKTBOOK 2.47 2.11 1.09 1.74 3.02 

Ϭ(CFO) 0.09 0.08 0.03 0.07 0.12 

Ϭ(SALES) 0.32 0.27 0.12 0.24 0.44 

Ϭ(I) 0.61 1.33 0.00 0.04 0.39 

ZSCORE 4.03 3.90 1.61 3.11 5.29 

TANGIBILITY 0.60 0.42 0.28 0.51 0.86 

CFOSALE 0.05 0.25 0.01 0.08 0.17 

SLACK 0.63 1.16 0.02 0.11 0.56 

OPCYCLE 4.76 0.65 4.33 4.82 5.25 

AGE 15.60 15.64 5.00 11.00 21.00 

Note. This table presents descriptive statistics of selected variables used in the main analyses. The sample includes 23,475 firm-year observations over the 

period 1983-2013. All variables are defined in Appendix A. 

 

Table 2 describes the relationship between the unionization rates and investment efficiency using logistic 

regressions. Columns (1) and (2) compare optimal investment with overinvestment and underinvestment respectively. 

Consistent with our primary hypotheses H1 and H2, investment efficiency resulting from mitigating both under- and 

overinvestment is positively associated with unionization rates. The results also reveal that larger firms (as measured by 

LOGAT) with a higher proportion of tangible assets (TANGIBILITY) and better growth opportunities (MKTBOOK) are 

more likely to overinvest (i.e. they display lower investment efficiency).  We believe that firm size, growth opportunities 

and tangibility of assets proxy for the complexity of the firms’ operations making it harder for outsiders to accurately observe 

managerial action, thereby making overinvestment more likely. Consistent with prior literature, larger firms are more likely 

to display investment efficiencies resulting from lower underinvestment due to more financing options available for larger 

firms. However, more leverage (D/A) increases underinvestment (i.e. it decreases investment efficiency) because any 

benefits from investing are captured primarily by debt holders thereby reducing managerial incentives to invest in marginally 

positive NPV projects. The pseudo r-squared ranges from 0.09 to 0.23 indicating that the models are well specified.  

 



Shin et al., Indian Journal of Finance and Banking 10(1) (2022), 1-11 

 

6 

Table 2. Unionization and Investment Efficiency 

 
 (1) Overinvestment (2) Underinvestment 

UNION 0.49** 0.76** 

 (2.07) (2.46) 

LOGAT -0.04*** 0.18*** 

 (-1.84) (9.03) 

D/A 0.75** -0.84*** 

 (4.05) (-4.27) 

MKTBOOK -0.17*** 0.04** 

 (-14.36) (3.22) 

Ϭ(CFO) -0.21 0.24 

 (-0.64) (0.68) 

Ϭ(SALES) -0.41*** -0.15 

 (-4.09) (-1.29) 

Ϭ(I) -0.03 0.01 

 (-1.34) (0.57) 

ZSCORE -0.00 0.04*** 

 (-1.33) (3.89) 

TANGIBILITY -1.01*** 0.99*** 

 (-9.25) (8.84) 

CFOSALE 0.85*** -0.26*** 

 (7.42) (-2.27) 

SLACK -0.09*** 0.08*** 

 (-3.76) (3.21) 

DIVIDEND -0.40 1.02* 

 (-0.57) (1.89) 

AGE 0.02*** -0.00*** 

 (8.41) (-3.73) 

OPCYCLE 0.16*** 0.22*** 

 (2.97) (3.61) 

LOSS 0.42*** -0.40*** 

 (7.71) (-7.78) 

Industry Fixed Effects Yes Yes 

Year Fixed Effects Yes Yes 

Firm Cluster Yes Yes 

Observations 17,392 17,398 

Pseudo R-squared 0.09 0.23 

Note. This table presents results from logistic pooled regressions of INVEFF on UNION. Column (1) presents the results for a sample that includes 

overinvestment and benchmark observations. Column (2) presents the results for a sample that includes underinvestment and benchmark observations. All 
variables are defined in Appendix A. Standard errors in parentheses are robust and adjusted using one-way clustering by firm. ***, **, and * indicate 

statistical significances at the 1%, 5%, and 10% levels, respectively. Tests are two-tailed. 

 

Table 3 provides evidence on the cross-sectional variation in investment efficiency that may arise from differences 

in the quality of the collective bargaining environment. Panels A and B show the unionization effects on investment 

efficiency partitioned by states where the Democratic Party is more influential and by states which have enacted Right-to-

Work (RTW) legislation, respectively. We find in Panel A that while unionization tends have a stronger effect on mitigating 

overinvestment in Democratic Party states, there seems to be no such difference in instances of underinvestment. In the 

underinvestment sample, the coefficients on UNION in both Democratic and Non-Democratic Party states are significant 

but a test of difference of coefficients reveals that the coefficients are not statistically different from each other. One reason 

for this could be that underinvestment in Republican states has been traditionally high due to the Republican Party’s 

skepticism of big infrastructure projects (Surowiecki, 2016). Thus, while unions may not be as powerful in Republican 

states, there may be more opportunities of underinvestment for unions to have a significant impact on, relative to those in 

Democratic Party states. Our results in Panel B on the union effects on investment efficiency partitioned by states that have 

and have not enacted RTW legislation, appear more robust.  In both overinvestment and underinvestment situations, the 

coefficient on UNION tends to be stronger in states which have not enacted RTW laws, i.e., in states where unions have 

greater bargaining power.  

 

Table 3. Cross-Sectional Variation in the Effect of Unionization on Investment Efficiency 

 
Panel A: Unionization Effect and Political Affiliation   

 Overinvestment Underinvestment 

 Democrat Non-Democrat Democrat Non-Democrat 

UNION 0.59* 0.47 0.84* 0.97** 

 (1.87) (1.25) (1.84) (2.19) 

Control Variables Yes Yes Yes Yes 

Industry Fixed Effects Yes Yes Yes Yes 

Year Fixed Effects Yes Yes Yes Yes 

Firm Cluster Yes Yes Yes Yes 

State Fixed Effects Yes Yes Yes Yes 



Shin et al., Indian Journal of Finance and Banking 10(1) (2022), 1-11 

 

7 

Observations 9,956 7,390 7,442 9,860 

Pseudo R-squared 0.11 0.11 0.26 0.23 

 
Panel B: Unionization Effect and Right-To-Work   

 Overinvestment Underinvestment 

 No RTW RTW No RTW RTW 

UNION 0.66** 0.31 1.42*** 0.22 

 (2.12) (0.80) (3.71) (0.43) 

Control Variables Yes Yes Yes Yes 

Industry Fixed Effects Yes Yes Yes Yes 

Year Fixed Effects Yes Yes Yes Yes 

Firm Cluster Yes Yes Yes Yes 

State Fixed Effects Yes Yes Yes Yes 

Observations 10,775 6,571 10,838 6,490 

Pseudo R-squared 0.09 0.09 0.23 0.26 

Note. This table presents results from the logistic pooled regressions of INVEFF on UNION and other control variables, partitioned by DEMOCRAT and 

Right-to-Work (RTW). Panel A presents the regression results of INVEFF on UNION and other control variables, partitioned for Democrat and Non-

Democrat states. Panel B presents the regression results of INVEFF on UNION and other control variables, partitioned for RTW and No-RTW states. All 
variables are defined in Appendix A. Standard errors in parentheses are robust and adjusted using one-way clustering by firm. ***, **, and * indicate 

statistical significances at the 1%, 5%, and 10% levels, respectively. Tests are two-tailed. 

 

As a robustness check, we decompose the overall investment into two components in Table 4 – CAPEX and 

NONCAPEX. Panel A shows that unionization improves investment efficiency associated with mitigating CAPEX 

underinvestment but not that associated with mitigating CAPEX overinvestment. The coefficient on UNION is not 

significant in the case of CAPEX overinvestment. One reason for the relatively weaker results in the case of CAPEX 

overinvestment is that unlike NONCAPEX expenditures such as R&D that is often governed by science and/or regulation, 

CAPEX investment decisions have more managerial discretion and may be more opaque in nature, making it harder for 

unions to monitor whether an investment is efficient or excessive. Panel B shows that unionization tends to increase 

NONCAPEX investment efficiency resulting from mitigating both overinvestment and underinvestment.  

 

Table 4. CAPEX vs. NONCAPEX Investment Efficiency and Unionization 

 
Panel A: Unionization Effect and CAPEX Investment Efficiency 

 Overinvestment Underinvestment 

 

UNION 0.15 0.76*** 

 (0.66) (3.29) 

Control Variables Yes Yes 

Industry Fixed Effects Yes Yes 

Year Fixed Effects Yes Yes 

Firm Cluster Yes Yes 

Observations 17,362 17,415 

Pseudo R-squared 0.08 0.21 

   

Panel B: Unionization Effect and NONCAPEX Investment Efficiency 

 Overinvestment Underinvestment 

 

UNION 0.78** 1.38*** 

 (2.08) (3.23) 

Control Variables Yes Yes 

Industry Fixed Effects Yes Yes 

Year Fixed Effects Yes Yes 

Firm Cluster Yes Yes 

Observations 17,302 15,187 

Pseudo R-squared 0.27 0.51 

Note. This table presents pooled time-series cross-sectional regressions of models predicting CAPEX and NONCAPEX investment. Panel A presents the 
regression results of INVEFF on UNION where INVEFF is based on the residuals computed from industry-year regressions of current CAPEX investment 

on lagged sales growth. Panel B presents the regression results of INVEFF on UNION where INVEFF is based on the residuals computed from industry-

year regressions of current NONCAPEX investment on lagged sales growth. All variables are defined in Appendix A. Standard errors in parentheses are 

robust and adjusted using one-way clustering by firm. ***, **, and * indicate statistical significances at the 1%, 5%, and 10% levels, respectively. Tests 

are two-tailed. 

 

Table 5 addresses the endogeneity of union membership by using an instrumental variables approach. Column (1) 

of Table 5 shows the first-stage results relating UNION to HHI, UNEMPRATE and OLDECON. Columns (2) and (3) report 

the second-stage results of the regression of INVEFF on the instrumented UNION value for the overinvestment and 

underinvestment sub-samples respectively. (Note 6) Consistent with our conjecture, UNION is positively associated with 

HHI, UNEMPRATE and OLDECON in Column (1). The second-stage results in Columns (2) and (3) continue to confirm 

our prior evidence from Table 3 on the strong association between unionization rates and investment efficiency. The 

instrumental variables coefficient is positive and statistically significant for both the overinvestment and underinvestment 

sub-samples. 



Shin et al., Indian Journal of Finance and Banking 10(1) (2022), 1-11 

 

8 

Table 5. Instrumental Variables Estimation for Addressing Endogeneity of Union Membership 

 

 (1) 

First Stage Regression 

Dep. Variable = UNION 

(2) 

Second Stage Regression. 

Dep. Variable = INVEFF 

(Overinvestment) 

(3) 

Second Stage Regression. 

Dep. Variable = INVEFF 

(Underinvestment) 

HHI 0.07*** 
 

 

 (3.32) 
 

 

UNEMPRATE 0.01*** 
 

 

 (10.01) 
 

 

OLDECON 0.05*** 
 

 

 (8.97) 
 

 

Instrumented UNION  1.55** 2.97 

  (2.04) (3.55) 

Control Variables No Yes Yes 

Industry Fixed Effects No Yes Yes 

Year Fixed Effects No Yes Yes 

Firm Cluster Yes Yes Yes 

Observations 23,425 17,359 17,363 

Adj. R-squared 0.05 0.09 0.23 

Note. This table presents results from the instrumental variables regressions for addressing endogeneity of UNION. Column (1) reports the results from 

the 1st-stage regressions of UNION on the instrumental variables (HHI, UNEMPRATE, and OLDECON). Columns (2) and (3) present the results from the 

2nd-stage Probit regressions of INVEFF on the instrumented UNION and control variables for the overinvestment and underinvestment sub-samples 
respectively. All variables are defined in Appendix A. Coefficients on control variables are excluded for brevity. Standard errors in parentheses are robust 

and adjusted using one-way clustering by firm. ***, **, and * indicate statistical significances at the 1%, 5%, and 10% levels, respectively. Tests are two-

tailed. 

 

Finally, Table 6 presents our main results using alternative measures of investment efficiency from Richardson 

(2006). Panel A presents the results from the expected model of investment in his study. The coefficients on all control 

variables load as expected—new investment expenditure increases with firm size, lagged cash holdings, lagged stock returns 

and prior investment expenditure and decreases with firm age and leverage. The positive and negative residuals from the 

model are then stored and analyzed separately in Panel B. Positive residuals (𝐼𝑂𝑣𝑒𝑟𝑖𝑛𝑣,𝑡
𝜀 ) from this model are deemed as 

overinvestment while negative residuals (𝐼𝑈𝑛𝑑𝑒𝑟𝑖𝑛𝑣,𝑡
𝜀 ) are interpreted as underinvestment. Panel B shows both pooled and 

Fama-Macbeth (1973) regressions separately of 𝐼𝑂𝑣𝑒𝑟𝑖𝑛𝑣,𝑡
𝜀  and 𝐼𝑈𝑛𝑑𝑒𝑟𝑖𝑛𝑣,𝑡

𝜀  on UNION.  The results continue to confirm our 

main hypotheses. UNION is negatively associated with 𝐼𝑂𝑣𝑒𝑟𝑖𝑛𝑣,𝑡
𝜀  (i.e. unionization makes the most positive residuals less 

positive) but positively associated with 𝐼𝑈𝑛𝑑𝑒𝑟𝑖𝑛𝑣,𝑡
𝜀  (i.e. unionization makes the most negative residuals less negative).  

 

Table 6. Alternative Investment Efficiency Measures 

 
Panel A: Expected Model of Investment 

 Predicted Sign   

V/Pt-1 - 
 

-0.01***    
(-10.75) 

Leveraget-1 - 
 

-0.03***    
(-18.82) 

Casht-1 + 
 

0.04***    
(19.76) 

Aget-1 - 
 

-0.00***    
(-7.29) 

Sizet-1 + 
 

0.00***    
(3.86) 

Stock Returnt-1 + 
 

0.01***    
(18.38) 

Inew,t-1 + 
 

0.47***    
(63.30) 

Year Indicators 
  

Yes 

Industry Indicators 
  

Yes 

Adjusted R-squared 
  

0.381 

 
 

 

 
 

 

 
 

 

 
 

 

Panel B: Relation between Investment Efficiency and Unionization Rates 

 (1) (2) (3) (4) 

     

Dependent Variable 𝐼𝑂𝑣𝑒𝑟𝐼𝑛𝑣,𝑡
𝜀  𝐼𝑂𝑣𝑒𝑟𝐼𝑛𝑣,𝑡

𝜀  𝐼𝑈𝑛𝑑𝑒𝑟𝐼𝑛𝑣,𝑡
𝜀  𝐼𝑈𝑛𝑑𝑒𝑟𝐼𝑛𝑣,𝑡

𝜀  

 (Pooled) (Fama-MacBeth) (Pooled) (Fama-MacBeth) 

     

UNION -0.06*** -0.08*** 0.04*** 0.05*** 

 (-7.62) (-5.91) (9.65) (6.96) 

Observations 8,529 8,141 11,786 11,243 

Adjusted R-squared 0.04 0.08 0.07 0.09 



Shin et al., Indian Journal of Finance and Banking 10(1) (2022), 1-11 

 

9 

Note. This table investigates the relationship between investment efficiency and unionization rates using investment efficiency measures from Richardson 

(2006). Panel A described the expected model of investment: 𝐼𝑁𝑒𝑤,𝑡 =  𝛼 + 𝛽1𝑉/𝑃𝑡−1 + 𝛽2𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒𝑡−1 + 𝛽2𝐶𝑎𝑠ℎ𝑡−1 + 𝛽2𝐴𝑔𝑒𝑡−1 + 𝛽2𝑆𝑖𝑧𝑒𝑡−1 +

𝛽2𝑆𝑡𝑜𝑐𝑘 𝑅𝑒𝑡𝑢𝑟𝑛𝑠𝑡−1 + 𝛽2𝐼𝑁𝑒𝑤,𝑡−1 + Σ𝑌𝑒𝑎𝑟 𝐼𝑛𝑑𝑖𝑐𝑎𝑡𝑜𝑟 + Σ𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝐼𝑛𝑑𝑖𝑐𝑎𝑡𝑜𝑟. 𝐼𝑁𝑒𝑤 is the difference between 𝐼𝑇𝑜𝑡𝑎𝑙  and 𝐼𝑀𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒. 𝐼𝑇𝑜𝑡𝑎𝑙 is total 

investment expenditure, calculated as the sum of Capex, acquisitions and R&D expenditures, minus sales of PPE. 𝐼𝑀𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 is investment expenditure 
necessary to maintain assets in place, using depreciation and amortization as a proxy. All other variables are as described in Richardson (2006). Panel B 
shows the regression of residuals estimated in Panel A on UNION. Positive residuals from this model are deemed as those representing overinvestment 

and are depicted by 𝐼𝑂𝑣𝑒𝑟𝐼𝑛𝑣,𝑡
𝜀 . Negative residuals from this model are deemed as those representing underinvestment and are depicted by 𝐼𝑈𝑛𝑑𝑒𝑟𝐼𝑛𝑣,𝑡

𝜀 . 

Standard errors in parentheses are robust and adjusted using one-way clustering by firm. ***, **, and * indicate statistical significances at the 1%, 5%, and 
10% levels, respectively. Tests are two-tailed. 

 

CONCLUSION 

We examine the effects of labor unionization in the U.S. and their interactions with political and legislative factors on firms’ 

investment decisions. We believe that this study is an important contribution to academic literature in this area given the 

recent focus on the political ramifications of unions’ collective bargaining. (Note 7) In this context, any study that is involved 

with revisiting or critiquing the contributions of unions to workers, firms and the economy at large, is likely to be of immense 

help not only to labor economists but also corporate finance academics and practitioners involved in understanding the 

determinants of corporate investment efficiency.  

Prior empirical evidence in the literature on union effects on economic performance has held the view that unions 

tax investments inducing firms to invest less in physical assets and R&D. The implication is that unions cause 

underinvestment that causes companies to shrink thereby creating a significant cost to the economy. We re-examine the 

evidence in this area by looking at whether the documented union effects on investment are a result of underinvestment or 

whether they are a mitigation of managerial inclinations to overinvest. We find evidence that unionization is associated with 

mitigating both overinvestment and underinvestment problems in firms. In other words, unionization appears to reduce 

significant deviations from optimal investment policy in both directions. This result is consistent with the larger governance 

and long-term role that unions play in firms’ strategic decisions. Furthermore, we generally find that the union effects on 

managerial inclinations tend to be stronger in environments where unions have greater bargaining power, indicating that the 

positive union effects on investment efficiency could likely be driven by the monitoring exercised by unions as part of its 

collective bargaining duties. Our results are robust to endogeneity of union membership, different empirical specifications, 

and alternative investment efficiency measures.   

 

 

Author Contributions: Conceptualization, Y.S., S.T., and Y.Z.; Data Curation, Y.S., S.T., and Y.Z.; Methodology, Y.S., S.T., and Y.Z.; Validation, Y.S., 
S.T., and Y.Z.; Visualization, Y.S., S.T., and Y.Z.; Formal Analysis, Y.S., S.T., and Y.Z.; Investigation, Y.S., S.T., and Y.Z.; Resources, Y.S., S.T., and 

Y.Z.; Writing – Original Draft, Y.S., S.T., and Y.Z.; Writing – Review & Editing, Y.S., S.T., and Y.Z.; Supervision, Y.S., S.T., and Y.Z.; Software, Y.S., 

S.T., and Y.Z.; Project Administration, Y.S., S.T., and Y.Z.; Funding Acquisition, Y.S., S.T., and Y.Z. Authors have read and agreed to the published 
version of the manuscript. 

Institutional Review Board Statement: Ethical review and approval were waived for this study, due to that the research does not deal with vulnerable 
groups or sensitive issues. 

Funding: The authors received no direct funding for this research. 

Informed Consent Statement: Informed consent was obtained from all subjects involved in the study. 

Data Availability Statement: The data presented in this study are available on request from the corresponding author. The data are not publicly available 
due to restrictions. 

Conflicts of Interest: The authors declare no conflict of interest.  

 

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NOTES 

Note 1. The positive union effects in states where the Democratic Party is more influential, is observed only in instances of 

overinvestment. 

Note 2. Unionization is positively associated with mitigating overinvestment of NonCapex investments only but not Capex 

investments. 

Note 3. Cho, Lee, Lee, and Sohn (2017) using 343 Korean firms also examine union effects on investment. In their setting, 

channels for variation in investment efficiency arise from corporate governance structures such as equity and foreign 

ownership. 

Note 4. To link the industry-level labor union data to firms in COMPUSTAT, we map the CIC or NAICS industry codes to 

SIC for all COMPUSTAT firms for each year. 

Note 5. All continuous variables are winsorized at the 5th and 95th percentile. 

Note 6. We use a Probit model in the second stage so that error terms in both the first and second stage can be assumed to 

be jointly bivariate normal. 

Note 7. The U.S. Supreme Court heard a case in 2016, challenging rules that force government workers to pay hefty fees to 



Shin et al., Indian Journal of Finance and Banking 10(1) (2022), 1-11 

 

11 

unions that they have no interest in joining. The unions had argued that such fees are vital to insure the operating efficiency 

and survival of companies. 

 

APPENDICES 

Appendix A: Variable Measurement for Regression Models 

  

INVEFF = Coded as 1 if a firm’s investment residual belongs to benchmark group; and 0 otherwise. 

INVESTMENT = The sum of R&D expenditure, Capex, and acquisition expenditure less cash receipts from sale of Property, 

Plant and Equipment (PPE) multiplied by 100 and scaled by total assets (TA). 

CAPEX = Capital expenditure multiplied by 100 and scaled by lagged PPE.  

NONCAPEX = The sum of R&D expenditure and acquisition expenditure multiplied by 100 and scaled by lagged TA. 

UNION = Calculated as the product of a firm’s number of employees and the percentage unionization rate within the firm’s 

SIC industry scaled by the book value of TA. 

LOGAT = The natural logarithm of TA. 

D/A = The ratio of total debts to TA. 

MKTBOOK = The ratio of the market value of TA to book value of TA. 

Ϭ(CFO) = Standard deviation of the cash flow from operations deflated by average TA from years t-5 to t-1. 

Ϭ(SALES) = Standard deviation of the Sales deflated by average TA from years t-5 to t-1. 

Ϭ(I) = Standard deviation of INVESTMENT from years t-5 to t-1. 

ZSCORE = Z-Score = 1.2*(Working Capital to TA) + 1.4*(Retained Earnings to TA) + 3.3*(EBIT to TA) + 0.6*(Market 

Value of Equity to Total Liabilities) + 1.0*(Sales to TA).  

TANGIBILITY = The ratio of PPE to TA. 

CFOSALE = The ratio of CFO to Sales. 

SLACK = The ratio of Cash to PPE 

DIVIDEND = An indicator variable that coded as 1 if the firm paid a dividend; 0 otherwise. 

AGE = the number of years a firm has been listed in CRSP. 

OPCYCLE = Natural Logarithm of the ratio of receivables to sales plus the ratio of inventory to COGS multiplied by 360. 

LOSS = An indicator variable that coded as 1 if net income before extraordinary items is negative; and 0 otherwise. 

DEMOCRAT = Coded as 1 if a firm’s operations are primarily located in a state that has consistently voted for the 

Democratic Party in most of the Presidential elections during the sample period; and 0 otherwise. 

RTW = 1 if the state in which the firm is primarily located, has enacted a Right-to-Work legislation; 0 otherwise.  

HHI = Herfindahl-Hirschman Index (HHI) measures the concentration of sales within a 3-digit SIC industry.  

OLDECON = Coded as 1 if a firm primarily operates in an “old-economy” industry where a firm’s SIC code lies between 

0100 and 3999, except computer industry (SIC codes: 3571, 3572, 3575 and 3577) and communications equipment 

industry (SIC codes: 3663, 3669 and 3674); 0 otherwise. 

UNEMPRATE = State-level unemployment rate in a particular year.  

 
 

 

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http://creativecommons.org/licenses/by/4.0/)
http://creativecommons.org/licenses/by/4.0/
http://creativecommons.org/licenses/by/4.0/

