Capital Structure and Employment Flexibility

IntroductionData and Empirical Strategy

Main ResultsMechanisms and Discussion

Capital Structure and Employment Flexibility

Olga KuzminaNew Economic School

The NES 20th Anniversary ConferenceDecember 14th, 2012

Olga Kuzmina Capital Structure and Employment Flexibility



Introduction

The motivation behind many labor policies in Europe isusually to promote employment and job security for workers.

However, it is important to understand how such policies canaffect firms, directly or indirectly.

Typical result in the unionization literature:more job protection for workers → worse firm outcomes

In this paper I explore how financing decisions of firms areaffected by the use of more flexible employment practices.

Simple and compelling channelCausal evidenceUnrelated to unionization and bargaining




Introduction

A more general framework: how a firm’s composition ofcontractual arrangements with its factors of production affectsits capital structure.

In an uncertain environment such flexible arrangements canallow firms to adjust their input costs and profits uponrealization of shocks

Effectively convert fixed operating costs into variable costsReduced operating leverage promotes financial leverage

Using a unique panel dataset and employing the exogenousvariation in government labor policies I establish a causal linkbetween the firm’s use of flexible employment contracts andits capital structure.




Mechanism

When firms employ temporary workers, they can adjustproduction/labor costs/profits upon shock realization

Temporary workers absorb a higher share of the volatility ofoutput (Spain: Alonso-Borrego et al., 2004; France: Blanchardand Landier, 2002; Italy: Kugler and Pica, 2004)

Flexible employment makes firms ”less risky”The fixed component of costs is lower, operating leverage fallsThe incidence of bankruptcy for a given level of debt falls

The firm can issue and service a higher level of debtReduction in operating leverage promotes financial leverage(Mandelker and Rhee, 1984)Real flexibility enhances debt capacity (Mauer and Triantis,1994)




The Other Side

Real decisions and flexibility can affect bankruptcy costs and debtcapacity

But financing policies themselves can induce different laboroutcomes/behavior:

Capital structure as a way to induce investment in firm-specifichuman capital(Butt Jaggia, Thakor, 1994; Berk, Stanton, Zechner, 2010)

Capital structure as a bargaining tool(Perotti, Spier, 1993; Matsa, 2010; Simintzi, Vig, Volpin, 2010)

→ Finding a correlation between (employment) flexibility andcapital structure does not reveal the direction of causality




Contribution of the Paper

Provide a causal evidence of flexible employment affectingcapital structure

Use a simple measure of employment flexibility

observed at the firm leveldo not rely on calibration or estimation (e.g. from industry)do not rely on reduced-form employment laws

Illustrate the exact mechanism behind this causal effect beingthe substitution between operating and financial leverage

Argue for the effect not being about unionization andbargaining




Related Empirical Literature

MacKay, 2003:

Mixed empirical results across calibrated measures of realflexibilities (potentially due to risk-shifting)

Hanka, 1998:

Empirically more debt is correlated with heavier reductions inemployment and relying more on part-time/seasonal labor

Petersen, 1994:

Flexible defined contribution pension plan (vs non-flexibledefined benefit) is correlated with less variable cash flow




Empirical Strategy

Dit = αrt + βTempit−1 + Xit−2′γ + ηi + εit

Controls for any firm-specific time-invariant characteristics, e.g.:

overall more or less variable cash flowsmall business with a distrust in credit and bankingtasks overall require more/less human capital specificitygeneral nature of assets

Region-year fixed effects control for:

differential access to credit over time in different locationsmacroeconomic effects driving the cost of financingunemployment rates and cross-regional trends in worker migration

Standard errors are clustered at the firm and region-year level inall the analysis.




Need for Exogenous Shock: why Cov(Temp, ε) 6= 0

Unobserved invesment opportunity set and potential for ex postproject substitution

Firms hire at more flexible terms ex ante → Temp ↑Lenders rationally expect project substitution → D ↓

Firm’s financial constraints (Caggese and Cunat, 2008)

Vulnerable to liquidity shocks, ”demand for flexibility” → Temp ↑Can’t get lending → D ↓

Desire to stimulate human capital investment (Butt Jaggia andThakor, 1994, and Berk, Stanton and Zechner, 2010)

Offer longer-term contracts → Temp ↓Pre-commit to less debt → D ↓




Why Spain?

Dual labor market: 1/3 of all employees are on T contracts.Big difference in firing costs across contract types:

0-12 days per year of tenure for T33-45 days per year of tenure (+ court fees) for P

Survey of manufacturing firms, ESEE, 1994-2006:can directly measure flexible contracts (T) at firm level.

Quasi-experiment: government subsidies implementeddifferentially by region, year, and worker characteristics.

Effectively ”control” for collective bargaining as it is not at thefirm level.




Maximum Subsidies across Regions




Graphical Evidence: by Year




Graphical Evidence: by Industry




Instrumental Variable: Example

A firm in Baleares in ”OTE” industry vs a firm in ”Apparel” in 2000:

Subsidygrt is 1653 Euro for female, 0 for maleEPA: 0.05 of all workers in OTE industry are females;EPA: 0.75 of all workers in Apparel industry are females;Assume each firm originally has 22% of Temps.

OTE firm is eligible to receive (per employee):0.22 ∗ (0.05 ∗ 1653 + 0.95 ∗ 0) = 0.22 ∗ 83 = 18 Euro

Apparel firm is eligible to receive (per employee):0.22 ∗ (0.75 ∗ 1653 + 0.25 ∗ 0) = 0.22 ∗ 1240 = 273 Euro

.. Another Apparel firm with 44% of Temps:0.44 ∗ (0.75 ∗ 1653 + 0.25 ∗ 0) = 0.44 ∗ 1240 = 546 Euro




Instrumental Variable: Example

A firm in Baleares in ”OTE” industry vs a firm in ”Apparel” in 2000:

Subsidygrt is 1653 Euro for female, 0 for maleEPA: 0.05 of all workers in OTE industry are females;EPA: 0.75 of all workers in Apparel industry are females;Assume each firm originally has 22% of Temps.

OTE firm is eligible to receive (per employee):0.22 ∗ (0.05 ∗ 1653 + 0.95 ∗ 0) = 0.22 ∗ 83 = 18 Euro

Apparel firm is eligible to receive (per employee):0.22 ∗ (0.75 ∗ 1653 + 0.25 ∗ 0) = 0.22 ∗ 1240 = 273 Euro

.. Another Apparel firm with 44% of Temps:0.44 ∗ (0.75 ∗ 1653 + 0.25 ∗ 0) = 0.44 ∗ 1240 = 546 Euro




Instrumental Variable

Subsidyit =∑

g wT0i w 0

sgSubsidygrt

Calculates the expected total real Euro value of subsidies a firmwould receive if it converted all of its temporary workers intopermanent ones, per employee.

Difference-in-differences analogy:Compare across firms that have high and low eligibilityCross-sectional variation captured by firm fixed effectsRegion-year fixed effects capture government choice of subsidyamounts (e.g. relative sizes of regional budgets)

Can intepret in ”intention-to-treat” frameworkActual subsidies cannot be used (endogenous participation)

Identification assumption: remaining variation is orthogonal tofirm-specific shocks




Summary Statistics

Variable Mean Std N

Total Assets 57.7mln 255mln 18365Total Debt / Total Assets 0.571 0.230 18365

Total Employment 269 783 18365Lagged Temp 0.174 0.210 18365Temp0 0.237 0.250 18364

Maximum Subsidy per T Worker 3523 4011 17488Maximum Subsidy per Employee 816 1538 17488

Size 16.013 2.014 18347Profitability 0.225 0.134 18346R&D 0.007 0.017 18246




Main Results

Total Debt / Total Assets

OLS IV-2SLS1st Stage 2nd Stage 1st Stage 2nd Stage

Lagged T 0.0597*** 0.0519*** 0.149** 0.168**(0.0118) (0.0132) (0.0582) (0.0766)

Lagged2 -0.0377*** -0.0269***Subsidy (0.00589) (0.00513)

N of firms 2244 2029 2226 2226 2013 2013Observations 17679 15091 16889 16889 14348 14348Within R2 0.027 0.032 0.150 0.128F-statistic 41.06 27.56

Firm controls Y Y YFirm FE Y Y Y Y Y YReg-year FE Y Y Y Y Y Y




Robustness: Additional Controls


IV-2SLSAdd Tangibility Add Average Wages

Lagged T 0.160* 0.168**(0.0819) (0.0766)

Lagged2 -0.0261*** -0.0269***Subsidy (0.00511) (0.00513)

N of firms 1977 1977 2013 2013Observations 13964 13964 14348 14348Within R2 0.128 0.128F-statistic 26.00 27.56

Firm controls Y Y Y YFirm FE Y Y Y YRegion-year FE Y Y Y Y




Robustness: Tighter Identification


IV-2SLSAdd Region-Industry-Year FEs

Lagged T 0.141** 0.169*(0.0648) (0.0887)

Lagged2 -0.0375*** -0.0262***Subsidy (0.00684) (0.00608)


Firm controls Y YFirm FE Y Y Y YReg-ind-year FE Y Y Y Y




Robustness: Originally-Sampled Firms


IV-2SLSSubsample Firms that enter in 1994

Lagged T 0.188** 0.229**(0.0788) (0.100)

Lagged2 -0.0408*** -0.0298***Subsidy (0.00634) (0.00541)


Firm controls Y YFirm FE Y Y Y YRegion-year FE Y Y Y Y




Identifying the Mechanism

If temporary workers indeed reduce probability of bankruptcy, then theoption to fire them is most valuable for firms with high levels ofbankruptcy costs.

For a given change in the proportion of temporary workers, the change inexpected bankruptcy costs is higher for such firms.The empirical relationship between capital structure and employmentflexibility should thus be stronger for these firms.

Want to compare firms with high and low levels of bankruptcy costs

Proxy with a low/high liquidation value of assets (whether the firm hasless/more land and buildings that industry peers)Idea: these assets are more easily redeployable and do not lose value undernew owners (Williamson, 1988, and Shleifer and Vishny, 1992)




Bankruptcy Costs Analysis

Total Debt / Total AssetsHigh * Lagged T 0.295** 0.378**

(0.119) (0.168)Low * Lagged T 0.0717 0.0664

(0.0648) (0.0851)

High * Lagged2 -0.0287*** -0.0193***Subsidy (0.00601) (0.00542)Low * Lagged2 -0.0404*** -0.0312***Subsidy (0.00601) (0.00544)

N of firms 2074 2074 1882 1882Observations 15858 15858 13484 13484F-statistic 12.27 7.07

Firm controls Y YFirm FE Y Y Y YRegion-year FE Y Y Y Y

Implied Difference -0.223* -0.312*p-value 0.081 0.081




Ex Post Bargaining?

Workers’ bargaining power ↑Precommit to high debt → Debt ↑[Matsa (2010) on USA state unionization laws]

Renegotiable debt → Debt ↓[Simintzi, Vig, Volpin (2011) on European EPL indicators]

Bargaining is not an omitted variable:

Less flexible labor is chosen for exogenous incentives, rather than inattempt to reduce employees’ bargaining power

Bargaining is not a likely channel:

85% of collective bargaining in Spanish manufacturing is NOT at the firmlevel (especially for smaller firms), but rather industry-regional or higher.These agreements apply to all firms equally irrespective of whether theyparticipated in the actual bargaining process and firms cannot discriminatebased on the contract type.




The Role of Cash

Subsidy is a cash inflow to firms:

Concern if this cash were used to pay out existing debt (effectoverestimated).Stronger results if used to raise more debt (effect underestimated).

The ideal if both cash balance and received subsidies were observed:

Show that for cash-abundant firms the effect is thereCompare changes in Debt to actual subsidies receivedNote: using (Debt-Cash)/Assets as the dependent variable would notsuffice

ESEE does not provide either, so:

Use proxies for cash abundancy and show the effect is thereUse a back-of-the-envelope calculation of received subsidies




Subsamples of Cash-Abundant Firms

CF = (Sales−COGS−OtherCosts)(1−τ)−CapitalExpenditures +AssetSales

Subsample CFt−2 CFtCF

TotalAssets t−2

CFt−2+CFt−1+CFt

TotalAssetst−2

>Ind Median >Ind Median >Ind Median >Ind Median


Lagged T 0.220** 0.191* 0.206** 0.258**(0.0903) (0.115) (0.102) (0.123)

Number of firms 1432 1433 1488 1370Observations 7142 7075 6883 68381st stage F-statistic 29.74 37.69 20.21 19.92

Firm controls Y Y Y YFirm FE Y Y Y YRegion-year FE Y Y Y Y




Back-of-the-Envelope Calculation

Average change in proportion of Temp is -0.00869(i.e. 0.87 pp per year)

*Av. Employment = Average Number of Contract Conversions= 0.00869*268.7378= 2.34 (per year)

*Av. Subsidy Per Contract = Average Received Subsidy =2.34*3523= 8227 (per year)

* 0.149 = Average Change in Debt / Total Assets implied bythe results = -0.00869*0.149 = -0.0013(i.e. 0.13 pp per year)

*Av. Total Assets = Average Change in Debt =−0.0013 ∗ 5.77 ∗ 107= 74766 (per year)

About 11% of the effect may be due to cash considerations

Robust to calculating by region




Conclusion

Firms that hire more temporary workers take more debt,controlling for time-invariant characteristics, debt-relatedcovariates, and non-parametric region-industry trends.

Differential regional subsidies provide an exogenous shock tofirms’ employment practices and enable to estimate the causaleffect of the use of more flexible employment contracts oncapital structure.

This causal effect is large: prohibiting an average firm fromhiring temporary workers would make it reduce its debt levelby 3.6 pp (6.3% of the average).

The results are interpreted in the framework of substitutionbetween operating and financial leverage.


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Capital Structure and Employment Flexibility