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«ABSTRACT We present evidence that financing frictions adversely impact investment in workplace safety, with implications for worker welfare and ...»

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Financing Constraints and Workplace Safety∗

Forthcoming, Journal of Finance

JONATHAN B. COHN AND MALCOLM I. WARDLAW

March 2016

ABSTRACT

We present evidence that financing frictions adversely impact investment in workplace

safety, with implications for worker welfare and firm value. Using several identification

strategies, we find that injury rates increase with leverage and negative cash flow shocks, and decrease with positive cash flow shocks. We show that firm value decreases substantially with injury rates. Our findings suggest that investment in worker safety is an economically important margin on which firms respond to financing constraints.

∗ Cohn is with the University of Texas at Austin. Wardlaw is with the University of Texas at Dallas.

We would like to thank Michael Roberts (Editor), the Associate Editor, two anonymous referees, Manuel Adelino, Ashwini Agrawal, Andres Almazan, Heitor Almeida, Aydoğan Altı, Sugato Bhattacharyya, Andres Donangelo, Jay Hartzell, Marcin Kacperczyk, David Matsa, Marco Pagano, Gordon Phillips, Giovanni Pica, Uday Rajan, Adriano Rampini, Avri Ravid, Nancy Rose, Bill Schwert, Amit Seru, Denis Sosyura, Sheridan Titman, Yongxiang Wang, Toni Whited, and seminar participants at the University of British Columbia, University of Illinois at Urbana-Champaign, University of Michigan, New York University, University of Ok- lahoma, University of Rochester, University of Southern California, University of Texas at Austin, University of Texas at Dallas, Bureau of Labor Statistics, 2013 CSEF Conference on Finance and Labor, and 2014 AFA for their comments. We would also like to thank Nicole Nestoriak from the Bureau of Labor Statistics for her assistance with the injury data. This paper benefited greatly from a UT-Austin McCombs Research Excellence Grant. The authors have read the Journal of Finance’s disclosure policy and have no conflicts of interest to disclose.

Over 3.5 million workplace injuries and illnesses occur in the U.

S. each year. The estimated annual cost of these injuries is $250 billion, more than the cost of all forms of cancer combined (Leigh (2001)). While workplace safety has been studied extensively in fields as diverse as industrial relations, operations management, and industrial-organizational psychology, its connections with finance remain largely unexplored. This paper studies how financing constraints impact workplace safety, which has implications for firm value and employee welfare.

Firms invest resources in improving workplace safety just as they invest in research and development, property, plant, and equipment, and organizational capital. As with other forms of investment, spending on safety must be financed out of either internal cash flow or externally-raised capital. In a world with financing frictions, a firm’s investment may be sensitive to the financial resources available to finance that investment. Thus the safety of a firm’s workplaces could depend on the financial resources at its disposal. Investment in safety may be especially vulnerable to cuts in the face of financing constraints, as its payoffs accrue slowly over time and are difficult to evaluate.

In this paper, we explore the impact of financing constraints on workplace safety by examining the sensitivity of workplace injury rates to the financial resources available to a firm using establishment-level injury data from the Bureau of Labor Statistics’ (BLS’) annual Survey of Occupational Injuries and Illnesses (SOII). As we lack exogenous variation in financial resources with which to completely isolate the effect of financing on injuries, we employ several empirical strategies. Each approach produces evidence pointing towards increased financial resource availability leading to fewer injuries, suggesting that financing constraints impair investment in safety. While any one piece of evidence is open to alternative interpretations, the evidence taken together is difficult to reconcile with any specific alternative.

We begin by examining the empirical relationship between injury rates and well-established 1 drivers of a firm’s capacity to finance investment, including cash flow, cash balances, and financial leverage. Cash balances and cash flow are sources of internal financing. Debt reduces cash flow through interest payments, and existing debt claims can make it difficult to raise additional external capital (Myers (1977)). Prior research shows that investment in general tends to increase with available cash (e.g., Fazzari, Hubbard, and Petersen (1988), Lamont (1997), Rauh (2006)) and decrease with leverage (e.g., Denis and Denis (1993), Lang, Ofek, and Stulz (1996)). If investment in safety is sensitive to a firm’s financial resources, then injury rates should decrease with cash flow and cash balances and increase with leverage.

We find a robust positive relation between injury rates and leverage, controlling for establishment and firm characteristics as well as establishment, industry-year, and state-year fixed effects. A one-standard-deviation increase in a firm’s debt-to-assets ratio is associated with a 5.6 percentage point increase in total workplace injuries the following year, relative to the sample mean injury rate. It is further associated with a 6.5 percentage point increase in injuries serious enough that the injured employee misses at least one full day of work, suggesting that it is not just minor injuries that are sensitive to leverage. These estimates are larger than existing estimates of the impact of penalty-imposing Occupational Safety and Health Administration (OSHA) inspections or plant unionization on workplace injury rates (Mendelhoff and Gray (2005)). Injury rates are sensitive to at least the first two annual lags of leverage but are unrelated to contemporaneous and future leverage, partially alleviating concerns about reverse causality.





Injury rates show strong negative relations with cash flow and cash balances in the crosssection. However, these relations disappear when we control for establishment fixed effects, suggesting that they may be driven by unobserved firm- or establishment-level heterogeneity.

We also find some evidence that injury rates are negatively related to dividend payout and firm size. As these characteristics are often seen as inverse proxies for the severity of financing constraints, this evidence provides added support for the role of financing constraints in 2 limiting investment in safety. Overall, the results from this analysis provide some support for the hypothesis that injury rates decrease with financial resources, though the evidence here is far from conclusive.

To better isolate the effect of financial resources on injury rates, we next study three quasinatural experiments involving cash flow shocks. These include a repatriation tax holiday in 2004, the onset of the financial crisis in 2007 and 2008, and large oil price fluctuations during the 2000s. Variants of each have been used in prior papers to study the effect of cash flow on capital investment.1 The cash flow shocks involved are large, plausibly exogenous with respect to injury rates, uncorrelated with each other, and affect some firms but not others. We exploit this last feature to conduct difference-in-differences analysis using matched samples, which mitigates though does not eliminate concerns about unobserved counterfactual changes in injury rates absent a shock. One useful feature of the set of experiments we study is that exposure is almost completely uncorrelated across the three, suggesting that they can be treated as three independent tests.

The results of these tests broadly support a negative (positive) response of injury rates to a positive (negative) cash flow shock, especially in firms with higher leverage. The estimates imply that, on average, a firm’s injury rate would fall by 8.4 to 11.9 percentage points in response to a one-standard-deviation increase in its cash flow. We verify that the differencein-differences estimates are unlikely to be driven by ex ante differences in treated and control establishments or by differential pre-existing trends in injury rates. While we cannot rule out the possibility that unobserved factors correlated with future trends in injury risk impact assignment, they would have to do so in ways that coincidentally produce consistent results across three separate experiments to explain the results. We also explicitly consider specific omitted characteristics, such as managerial skill and production technology, and conclude that it would be difficult for any single characteristic to explain all of the results in the paper.

The weight of the evidence thus appears to support financing constraints as the most likely 3 mechanism driving the results.

Stakeholder theory argues that a firm indirectly bears costs, in expectation, that its financial policies impose on nonfinancial stakeholders such as employees ex post (Titman (1984)). The natural channel in the case of costs due to higher workplace injury risk is a compensating wage differential that employees require to bear this risk. Firms may also bear costs directly in the form of decreased productivity resulting from increased downtime and poor employee morale.2 In the last part of our analysis, we find a substantial negative relation between firm value and injury rates, with firm value decreasing by 6.1% for each one-standard-deviation increase in injury rate. While we cannot rule out the possibility of alternative explanations for this relation, the estimates imply plausible costs per injury in light of existing estimates of compensating wage differentials (Viscusi and Aldy (2003)). The results also imply that greater workplace injury risk may be a significant cost of policies that increase the likelihood that financing constraints bind in the future.

Our paper adds to a small set of papers examining the impact of financing on the risks faced by nonfinancial stakeholders in a firm. Rose (1990) and Dionne et al. (1997) find that the likelihood of serious accidents in the airline industry is negatively correlated with operating margins. Dionne et al. (1997) find some evidence that leverage impacts the likelihood of airline accidents, but only for carriers with negative equity. Phillips and Sertsios (2013) find that airlines mishandle more baggage and have fewer on-time arrivals when they are in financial distress. Beard (1992) finds that roadside inspection violations decrease with trucking company equity valuation. These studies are limited to a small number of firms in specific industries and do not focus on employee safety. In a current working paper, Kini, Shenoy, and Subramaniam (2014) present evidence that the likelihood of a product recall increases with a firm’s leverage.

The closest papers to ours are Filer and Golbe (2003) and Nie and Zhao (2015). Filer and Golbe (2003) find that firms with more debt have fewer OSHA safety violations, a conclusion 4 seemingly at odds with ours. However, their sample is small and they do not control for establishment or firm fixed effects. Moreover, they measure inspection violations rather than actual injuries, and constrained firms may cut spending on safety in ways that affect injury risk but do not trigger OSHA violations. In a recent working paper, Nie and Zhao (2015) show that workplace fatalities are positively related to firm leverage in China’s coalmining industry.

Our paper also contributes to a small literature studying the effects of financing on employee welfare more generally. Gordon (1998) shows that higher firm debt levels are associated with reductions in employment that are not fully attributable to performance.

Benmelech, Bergman, and Seru (2011) show that employment levels are sensitive to cash flow and that this sensitivity is greater for firms with higher leverage. Agrawal and Matsa (2013) present evidence that firms increase leverage in response to exogenous increases in unemployment benefits, suggesting that they internalize at least part of the cost of unemployment risk. Bronars and Deere (1991) and Matsa (2010) find that firms use financial leverage to gain bargaining power over their unions, suggesting that financing may impact employee wages. Ours is the first study we are aware of to provide evidence that financing impacts employee welfare through channels other than employment and compensation.3 The remainder of the paper is as follows. Section I discusses workplace safety and the potential impact of financing constraints on safety. In Section II, we describe our data and sample. Analysis of the determinants of injury rates is presented in Section III. We present results from the three quasi-natural experiments in Section IV. In Section V, we analyze the link between firm value and injury risk. Finally, Section VI concludes.

5 I. Financing Constraints and Workplace Safety

In this section, we discuss how firms invest in workplace safety and how financing constraints potentially impact this investment. This discussion is based largely on conversations with industrial safety practitioners and a case study on safety at Alcoa by Clark and Margolis (2000). We also discuss the ideal experiment for testing the impact of financing constraints on injury rates as well as the main challenge in approximating this ideal experiment with actual data.

A. Financial Resources and Investment in Workplace Safety

Workplace safety is instrumental to employee well-being. Poor safety conditions were a major driver behind the spread of unions in the U.S. in the early 1900s and ultimately led to major labor reforms (Brody (1960)). Yet many jobs remain inherently risky. Table I shows the percentage of injuries in the U.S. in 2012 by different causes (Panel A) and types (Panel B) as reported in the BLS’ annual news release on employer-related workplace injuries and illnesses. The leading causes of workplace injuries are contact with objects, falls, and physical overexertion, while the most common injury types are sprains, strains or tears, soreness and pain, bruises and contusions, cuts and lacerations, and fractures.

— Insert Table I here — Firms invest in a number of activities that reduce the risk of on-the-job injury. Some of these activities involve direct expenditures on the acquisition and upkeep of physical assets.



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