How unions impact financial reporting

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It’s hard to predict how a company will react to employee unionisation. While unions have netted society-wide benefits for workers, many companies still consider them an operational risk to be mitigated.

We’ll hear about the most extreme cases in public news stories, such as when a company shuts down its warehouse to avoid dealing with an organised labour force. But unions can also have less visible impacts on company operations, as was discovered in a recent study by Professor Vivek Astvansh and his co-authors.

Astvansh is an associate professor of Quantitative Marketing and Analytics at the Desautels Faculty of Management at McGill University. In their paper, he and his co-authors (Beibei Wang and Tao Chen) investigated union’s impact on a company’s accounting practices. They discovered that, in response to a newly formed union, companies attempt to downplay their financial health.

“Labour unionisation offers managers a reason to play down their performance,” said Astvansh.

Why? To prepare for upcoming negotiations. Unionised employees might view high performance as a reason to negotiate higher salaries and benefits, said Astvansh. By playing down their earnings, managers hope to reduce the cost of increased worker demands.

(Un)real earnings management

Managers can downplay or play up their finances through a process called real earnings management.  By deferring expenses, prematurely recording revenue, or altering actual business practices that affect cash flow and operations, companies can manipulate their earnings to appear stronger in the eyes of shareholders. For example, by deferring a million-dollar project to the next fiscal year, they can boast about an extra million dollars in their coffers in their latest quarterly report.

But, as Astvansh discovered, companies drop this kind of earnings management after employees unionise. He and his colleagues studied 654 companies that experienced close-call labour elections from 1989 to 2021. On average, these companies stopped or reduced their earnings management post-election, resulting in less inflated numbers that more accurately reflected the financial state of the company.

By-and-large, this can be viewed as a positive development.

“All else equal, stakeholders may prefer managers to report the performance ‘as is’ and not use accounting standards to manage performance,” said Astvansh.

The abandonment of earnings management was an unintended outcome of unionisation efforts, explained Astvansh. Unions are typically concerned with winning higher salaries and improved employee working conditions. But in this case, they accidentally incentivised greater market transparency between companies and their stakeholders.

This discovery speaks to myriad variables and pressures managers contend with on a daily basis, and how they might navigate those complicated circumstances.