When is cash not king? Holding excess cash reserves can be less desirable when a firm has a more unionized workforce. In new research forthcoming in Journal of Financial Economics, Finance Professor William Maxwell of SMU Cox and co-authors find that firms in more unionized industries strategically hold less cash to gain bargaining advantages over union demands. But there are trade-offs in holding less cash.   For example, in the case of Ford Motor Co., cash saved the day in comparison to the morass in which General Motors (GM) and Chrysler find themselves.

Maxwell says, “The risk of holding lower cash reserves becomes apparent when there’s an economic downturn. Without cash on hand, a firm could suffer the fate of GM or Chrysler and go into bankruptcy.” He continues, “Though Ford has been losing money, it has had enough cash for operations. So Ford doesn’t have to look to the government for cash and hasn’t been pushed toward bankruptcy.” Clearly, Ford in this instance has more control over its own fate, and the trade-off about cash holdings becomes apparent.

In the research, other dynamics between corporate finance decisions and labor were revealed. Firms which have a more unionized workforce tend to hold less cash than a non-unionized workforce. In this case, these firms likely place a higher value on gaining a bargaining advantage over unions. Large cash reserves weaken a firm’s bargaining position and then labor can capture a larger portion of the profits. It can also embolden union to strike.

Maxwell says this is one ‘agency cost’ of cash that a firm must balance to determine an optimal cash level.  “If you’re a CEO you want a lot of cash on hand; it protects you. Until the present financial crisis, the common refrain was a well-run, profitable firm can always go back to the financial markets to raise cash during down periods; good companies are not shut out of financial markets. But if you’re a problematic company, then it is harder to raise cash.”

 
Market penalties and global competition

Markets discount excess cash held by firms with more unionized workforces. The authors find that each excess or marginal dollar held by a firm is discounted to 87 cents on the dollar for unionized firms. Take Chrysler for example. If Chrysler has $2 billion in cash, which is necessary to operate the company, but excess cash holdings are $8 billion, how would that impact firm value? It’s not $ 8 billion. “The agency problems, like unions, make the value of those extra holdings 87 cents on the dollar,” Maxwell explains. “How is this excess cash to be used—possibly for bad decisions by managers that are wasteful (e.g., a higher-end jet) as managers can choose to be prudent or not.  It is also easy for unions to point to the cash holdings of the firm when negotiating with the company.   It is hard for a firm to argue it is poor if it has billions sitting around in marketable securities.  In many ways, it is like waving a red cape in front of a bull, and not surprisingly the unions are going make demands accordingly.  The end result, investors realize this and ‘these additional dollars are discounted by the market as they know they are going to evaporate through management decisions or unions demands.’

Investors are more perceptive about these things and firms can no longer sit on hoards of cash like in the past, Maxwell mentions. There’s more pressure on firms, and finance has become more systematic. This change started in the mid-80s, with numerous firms being broken up. Imprudent firms could no longer survive.  But in general, over time average cash reserves corporate-wide have gone up and given the idea that firms need cash to be competitive.

The global competition card plays out in the cash reserves-unionization scenario.  Global competition requires firms to carry more cash for preventive purposes and reduces union bargaining power.  With modern manufacturing production methodologies, most auto plants make things the same way.  There’s not much difference in production between GM and Toyota plants, Maxwell notes. The number of total labor hours per unit (per car) is very close, perhaps an hour or two difference. “The biggest difference is the legacy costs for the automakers, funding the past promises they made,” he says. “It’s a couple thousand dollars per car tacked onto the price. They are paying for bad past decisions (too rich of benefits) or that they did not put enough money aside for those commitments, ie., underfunding their pension and health care obligations.”  While it is easy to blame the union, it’s not necessarily the unions at fault either, Maxwell says.  It’s the managers and boards that agreed to any contracts.  If they were onerous, it was their fiduciary duty of the board and directors to reject the contracts.

There’s a reason manufacturing jobs are declining in Detroit, Ohio, New York, Pennsylvania—from New York to Ohio and across. Why? “Because firms don’t want a unionized workforce,” Maxwell offers. “Why would a firm want to have an adversarial relationship with its employees?  People are the greatest asset of a firm.  Employees produce the goods and services that the firm sells.   Successful, top performing companies treat their employees well. Some managers seem to forget this — and it is in this environment you can see unions forming.”

 
Other results

The paper goes further and demonstrates how the existence of right-to-work laws in particular states, which weakens unions' bargaining power, impacts the firm’s decision to hold cash less. Holding less cash due to increased unionization was also more pronounced for firms in more concentrated industries and firms in which labor costs are a larger percent of total costs. When a firm’s bond rating improves to investment grade during a prior year, the likelihood of a strike increases. Thus, the authors suggest that firms that appear to be financially stronger have weaker bargaining positions vis-à-vis unions.

Generally speaking, the results suggest that large cash reserves are costly for firms in more unionized industries because they weaken the firm’s bargaining position and permit unionized workers to capture a larger fraction of the firm’s profits. In addition, two case histories confirm findings of the paper.  The paper shows the differences in the cash holding practices of Nucor, a non-unionized steel firm, versus its unionized competitors. And second, it tracks the changes in the FedEx's cash holdings before and after the pilots voted to unionize.

In summary, there are many factors that determine an optimal level of cash holdings for a firm.  One of these factors is the type of workforce employed.  Unionized firms are more likely to hold lower cash reserves giving up some of the benefits of corporate cash reserves — such as future growth opportunities.


“The strategic use of corporate cash holdings in collective bargaining with labor unions” by Finance Professor William Maxwell of SMU Cox School of Business, Sandy Klasa of University of Arizona, and Hernán Ortiz-Molina of University of British Columbia is forthcoming in Journal of Financial Economics.

Written by Jennifer Warren.