Debt Structure as a Strategic Bargaining Tool

The bargaining theory of corporate debt suggests that a firm's management could use debt policies to influence its bargaining position relative to non-financial stakeholders such as employees. However, empirical evidence is mixed despite the theoretical appeal. In this paper, I propose a way to resolve the conflicting views in the literature. I find strong causal evidence supporting the strategic bargaining view when taking debt heterogeneity into consideration.

The basic theoretical mechanism is that debt creates a commitment to make payments to creditors and hence reduces the surplus over which labor can negotiate with management without forcing firms into bankruptcy, which imposes larger costs on organized labor than private workouts. From this point of view, what is critical is the commitment level of the debt and the credibility of the bankruptcy threats, which depend on the ease of renegotiating debt contracts.

The credibility of bankruptcy threats varies across different types of debt. For example, it is higher for public debt relative to bank debt because renegotiating the former is more difficult because of the existence of the Trust Indenture Act of 1939. The latter, however, can be renegotiated more easily and is indeed frequently renegotiated before maturity. Within bank debt, the renegotiation likelihood also varies. It decreases with syndication size because contract renegotiation becomes more difficult with more creditors. Thus, a proper test of the theory on the strategic use of debt in managerial bargaining should take into consideration the structure of the firm's debt, not just the level of debt.

The main findings are as follows. First, I show that debt structure is adjusted strategically as a response to an increase in employees' bargaining power. Regression discontinuity (RD) estimations show that while the causal impact of union certification on the corporate leverage ratio is negligible, debt structure is adjusted toward public debt, which is more difficult to be renegotiated, after union certification.

Second, I find that union certification leads to a more dispersed syndication structure of newly issued bank loans. Specifically, passing a labor union election on average leads to an increase in the number of creditors and a decrease in the creditor ownership concentration in a bank loan tranche.

Finally, I further perform tests to rule out alternative explanations. One concern about the empirical results is that debt structure adjustments after union certification could only be responses to changes in other firm characteristics and have nothing to do with management’s behavior. To mitigate the proposed concern, I show that union certification has little effects on the changes in firm characteristics that are important for debt structure choice.

Another alternative explanation for the documented findings is that firms could be more constrained from bank loan markets after union certification and have to resort to the bond market for financing. One of the tests that I use to address this concern is to exploit the cross-sectional variation in the interest alignment between labor and management before elections. If the alternative channel drives my results, I expect the debt structure adjustments to be larger when the interests of labor unions are more aligned with managements', since labor unions then have more incentives to engage in the behavior that benefits shareholders at the cost of bank creditors and exaggerate the conflicts with banks.

However, I find that debt structure adjustments are smaller, not larger, after union certification when the interests between labor and management are more aligned before elections. Therefore, the cross-sectional evidence is inconsistent with the alternative explanation but is more consistent with the strategic bargaining view because the need for strategic bargaining is reduced when the two parties have more common interests.

My paper contributes to the literature by showing the importance of debt heterogeneity, which affects the credibility of bankruptcy threats. Even though in this paper I focus on firms' interactions with one important non-financial stakeholder - labor unions - the results have a broader implication. As long as the bankruptcy procedure imposes larger costs on non-financial stakeholders in a firm than private workouts (e.g., lessors), then debt structure could be an effective bargaining tool for management during the negotiations with them because it alters the bankruptcy threats.

Yue Qiu is an Assistant Professor of Finance at the Fox School of Business, Temple University