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Negotiating with Labor under Financial Distress

By Harvard Law School Program on Corporate Governance

In my paper, Negotiating with Labor under Financial Distress, which I recently presented at the Law, Economics and Organizations Seminar here at Harvard Law School, my co-authors, Nittai Bergman and Ricardo Enriquez, and I analyze how firms strategically renegotiate labor contracts to extract concessions from labor. While anecdotal evidence suggests that firms tend to renegotiate down wages in times of financial distress, there is no empirical evidence that documents such renegotiation, its determinants, and its magnitude. This paper attempts to fill this gap. More specifically, we use a unique data set of airlines that includes detailed information on wages, benefits and pension plans, to document an empirical link between airline financial distress, pension underfunding, and wage concessions.

We first show that airlines in financial distress obtain wage concession from employees whose pension plans are underfunded. An underfunded plan is one in which plan assets are insufficient to cover outstanding benefit obligations. Employees with underfunded pension plans can in some situations bear a higher cost when firms default if the benefits promised to them exceed the benefit limits set by the Pension Benefit Guaranty Corporation (PBGC), the federal corporation which protects the pensions of nearly 44 million American workers. The maximum annual guarantee is determined by employee age and was $30,978 for a 60 year-old employee in 2006.

Since highly-paid employees with promised pensions that exceed the PBGC guarantee stand to lose more when their pension is transferred to the PBGC, we hypothesize that they will be more likely to make concessions during labor bargaining. Our identification strategy thus relies on a triple-difference, or DDD, specification, with three levels of differences: (i) financially distressed vs. non-distressed airlines, (ii) underfunded pension plans vs. funded plans, and (iii) wages exceeding vs. those that are below the PBGC limit.

We find that airlines that are financially distressed can negotiate down the wages of their employees whose pensions are underfunded and are not fully covered by the PBGC guarantee. The magnitude of the triple difference estimator suggests that in such renegotiation annual wages are reduced by between 9.3% and 11.2%. Analyzing levels instead of the percentage change shows that in renegotiation financially constrained airlines with underfunded pension plans extract between $12,252 and $17,360 in annual wages from employees not fully covered by the PBGC guarantee. Our results are robust to the inclusion of year, airline, plan and airline by-year fixed effects in addition to airline and employee controls.

We also control for the share of the airline wage expense in two ways. First, we control throughout our analysis for the ratio between the wage of an employee group and overall firm wage expenses and find that our results are always robust to the inclusion of the wage share variable. Second, we employ a placebo test to analyze the effect of the PBGC guarantee. Specifically, we compare wage renegotiation in airlines with deeply underfunded plans (the treatment group) to wage renegotiation in similar employee groups in airlines with no defined-benefits plans (the placebo group). We find that amongst highly paid employee groups with wages not fully covered by the PBGC guarantee, only those with a pension plan, and in particular one that is underfunded, agree to accept wage reductions in renegotiation. In contrast, identical highly paid employee groups employed in airlines without defined benefit plans do not accept wage cuts in renegotiation. Thus, our results are not likely driven simply by some employee groups making wage concessions for reasons unrelated to pension underfunding.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on September 23, 2009 (boomark / email).