Unionization and employee welfare: a theoretical investigation using earnings management

Purpose - Unionization is generally thought to improve employee welfare through higher compensation and benefits. However, managers of unionized firms have incentives to manage earnings downward to avoid sharing rents with unionized workers, which may explain why empirical findings on the association between unionization and employee compensation are mixed. This paper develops an analytical model incorporating earnings management into the relationship between newly unionized firms and employee compensation. Design/methodology/approach - The authors develop an analytical model that relies on Nash bargaining theory and signal jamming (Stein, 1989; Fischer and Verrecchia, 2000; Dye and Sridhar, 2004) and model a setting where newly unionized workers' collective bargaining power increases substantially. The authors' model analyzes the relationship between newly unionized firms and employee wages and benefits while incorporating firms' incentives to engage in earnings management. Findings - The authors find that newly unionized firms are more likely to engage in income-decreasing earnings management to avoid paying higher salaries and wages to workers. Further, the authors find that this association is more pronounced when (1) the correlation of firms' earnings across periods is higher, (2) the cost of earnings management is lower and (3) firms' earnings are more volatile. Originality/value - This is the first paper to analytically model the effect of new unionization on firms' earnings management and workers' welfare. The authors' model offers new cross-sectional predictions that have not been tested in the prior literature. Specifically, the authors show that newly unionized firms are more likely to engage in income-decreasing earnings management; when earnings are more highly correlated, the cost of earnings management is lower and earnings are more volatile. The authors' findings may be relevant to regulators and policymakers.