Labor unions and real earnings management

Abstract

Using firm-level union membership data for the period of 2002–2016, we show that firms with higher union membership are more likely to engage in real earnings management than accrual-based earnings management, with abnormal production as the dominant form of real earnings management. We further show the causal effect of union membership on real earnings management by exploiting two natural experiments-the staggered enactment of state-level right-to-work (RTW) laws and the shock to unemployment insurance benefits (UIB)-as exogenous shocks to union power. Further exploration shows that the positive association between union membership and real earnings management is more pronounced for unionized firms with (1) high managerial incentives to reduce employee hiring and retention costs and (2) operating inflexibility created by labor overinvestment. Our evidence is consistent with managerial incentives for upward earnings management to mitigate employees' perceived job security and the cost of employee management in competitive labor markets.