The Relationship between Labor Union Strikes and Earnings Management from Korean Evidence
Authors:   Asia-Europe Perspective Association, Kim Su-In , Shin Hyejeong , Shin Heejeong 
Published: October 2019

This paper investigates whether labor union strikes have an effect on earnings management.
Most prior studies have concluded that companies with labor unions are less engaged in earnings management than companies without labor unions. For the agency cost perspective, Jensen and Meckling (1976) insist that labor unions monitor management. Because union members have considerable information about companies, labor unions play a governance role to diminish management behavior pursuing private wealth. On the different view, labor unions intend to raise wages in negotiation if the company reports higher earnings. Therefore, management is motivated to reduce earnings to minimize wage increases when they negotiate with labor unions (Liberty and Zimmerman, 1986; Mora and Sabater, 2008).
Chen et al. (2012) show that companies in the industry with higher labor force unionized rate have more positive response in the bond market. They posit that unionized workers have strong incentive to monitor management’s actions to ensure the firm’s health and that the market reacts positively. Lee et al. (2013) show that management engages in more conservative accounting when labor unions join stronger federations of unions. Kim et al. (2016), however, suggest that management is incentivized to increase earnings in firms with union strikes. They conclude that firms that experience labor strikes are engaged in upward earnings management because management tries to recover poor financial performance and bad reputation in the market due to strike.
As for labor union strength and earnings management, different perspectives of management incentive to manage earnings stand opposed to each other, and the empirical results are not consistent. It is therefore important to investigate empirically whether earnings management varies according to labor union strength and whether the effect of labor union strength on earnings management is different from the effect of labor union presence on earnings management.
Unlike the prior research, we use union strike as a proxy of union strength to investigate the effect of labor union strength on earnings management. Union activity such as strike is a better proxy because strike is occurred by the union when the union has strong bargaining power (Myers and Saretto, 2010).
We conjecture that managements have complicated motivations to manage reported earnings according to union strikes. On the one hand, they have incentive to manage earnings downward for negotiations with labor unions. Managements lower the upper limit of future wage increase by reducing reported earnings. On the other hand, managements would manage earnings upward to recover from bad financial performance and declining stock prices caused by union strikes because shareholders regard strikes costly events.
To examine our research question, we use union strikes as a proxy for unions, while prior research used unionized rate or federation of unions to capture union strength.
Using Korean listed firms from survey data from 2005 to 2013, we find that union strikes relate to increased earnings management. We observe earnings management increase in strike years compared to the prior year. This result is robust after controlling for the presence of union, which has a negative coefficient. This suggests that management has complicated incentives regarding union and union strike, while prior research insists that management reduces earnings management by union monitoring. Management intends to increase reported earnings since strikes negatively affect firm financial performance and market reaction, while they intend to reduce earnings due to union monitoring.