Right to work laws are good---key to sustain corporate innovation.

The Taft-Hartley Act of 1947 allows U.S. states to enact the highly controversial Right-to-Work (RTW hereafter) laws, which permit employees to enjoy the benefits defined in the collective-bargaining agreements negotiated by labor unions without having to join unions or pay union dues. Despite the controversy over the RTW laws and the strong resistance from unions,1 27 states have adopted the RTW so far. The RTW recognition is shown to significantly weaken labor unions' bargaining power and their activities (Chava et al., 2020; Ellwood and Fine, 1987; Hirsch, 1980; Warren Jr and Strauss, 1979), and enhance employment, but have mixed effects on wages (Chava et al., 2020; Kalenkoski and Lacombe, 2006; Reed, 2003). The RTW laws are also shown to decrease corporate financial leverage while increase tangible investment and profitability (Chava et al., 2020). In this paper, we show that the RTW exerts a significant and positive effect on corporate innovation—the enactment of state RTW laws strongly encourages firms to generate innovation outputs with higher quantity and quality and, as a result, gain stronger competitiveness over product market rivals. Corporate innovation activities can bring significant benefits not only to shareholders in terms of shareholder wealth creation, but also to corporate managers themselves in terms of personal reputation, social status, and private benefits of control (see, e.g., Balkin et al., 2000; Lerner and Wulf, 2007; Makri et al., 2006). However, when an innovating firm falls into financial distress, in addition to shareholder value loss due to the low liquidation value of intangible assets, managers will lose their personal reputation and private benefits of control. Thus, we conjecture that an increase (a decrease) in financial distress risk discourages (encourages) corporate innovation activities.2 Unionization increases a firm's operating leverage since it is more difficult to lay off unionized workers than non-unionized ones. For example, Chen et al. (2011) show that unionization is positively related to various measures of operating leverage and the constraints on firms' operations imposed by labor unions significantly increase firms' costs of equity. The RTW weakens the bargaining power of labor unions and thus decreases treated firms' operating leverage through increasing their flexibility on wages and employment, and also leads to a drop in treated firms' financial leverage because the need to use high financial leverage as a strategic tool to bargain with unions subsides after the RTW adoption (Chava et al., 2020). Against this backdrop, we conjecture that as operating and financial leverages decrease following the state RTW adoption, financial distress risk also decreases and thus treated firms can now more freely conduct innovation activities—that is, the RTW may encourage treated firms' innovation activities. We investigate this conjecture using a comprehensive sample of patenting firms covering a sample period of over six decades from 1950 to 2017 and a difference-in-differences (DiD) regression framework. Consistent with our expectation, the empirical evidence strongly suggests that the state adoption of the RTW results in significantly greater future patent grants and patent citations for firms headquartered in that state.3 Three years after the state RTW adoption, an average treated firm increases its patent count by 1.66 per 10-million-dollars sales, and increases its patent citation count by 19.78 per 10-million-dollars sales, which equal 0.28 and 0.21 sample standard deviation, respectively. These findings are robust to controlling for various time-varying firm characteristics and state economic conditions, as well as industry-year fixed effects (which capture the impact of potential industry-wide economic shocks) and firm fixed effects (which capture any time-invariant firm heterogeneity). We also document a robust treatment effect of the RTW on corporate innovation in different subperiods. Results from our dynamic DiD tests further reveal that the positive effects of the RTW on both the quantity and quality of treated firms' innovation outputs only show up from the third year following the adoption of the RTW and become stronger in subsequent years. These findings suggest that the trends in innovation between the control and treatment firms are parallel before the onset of the treatment and thus the documented effects of the RTW laws on corporate innovation activities are most likely causal. Although we control for time-varying state economic conditions in our baseline DiD regressions, unobserved local economic conditions may still confound our results. For example, some unobserved local economic conditions such as the evolution of regional innovation ecosystem can both lead to an increase in future innovation outputs of local firms and lead local governments to adopt the RTW laws. To address this potential concern, we further restrict control firms to those located in neighboring non-RTW states, since neighboring states have arguably similar local market dynamics as the treated firm's headquarter state. Our DiD estimation using neighboring-state control firms shows qualitatively similar (or even stronger) results. Thus, we conclude that our findings are most likely driven by the state RTW adoption rather than by unobservable local economic conditions. Moreover, consistent with the notion that the RTW encourages corporate innovations through weakening labor unions' bargaining power, we find that the economic impact of the RTW on innovation activities shows up mainly among highly unionized firms. As we conjecture that the RTW encourages corporate innovations through reducing financial distress risk, we next investigate the impact of the RTW on treated firms' ex-post changes in distress risk. Following the literature (e.g., Bharath and Shumway, 2008; Brogaard et al., 2017; Farre-Mensa and Ljungqvist, 2016), we use Merton's (1974) Distance-to-Default metric, which measures the firm's default probability, to capture distress risk. We find that following the state RTW adoption, treated firms on average experience a significant reduction in distress risk by about 2 percentage points relative to control firms. Moreover, consistent with the RTW encouraging corporate innovations through weakening labor unions and thus reducing financial distress risk for treated firms, we find that the treatment effect of the RTW on innovation outcomes is significantly stronger for those treated firms that have higher default probability ex ante. In addition, we further document that the positive treatment effect of the RTW on patent grants and patent citation count is significantly stronger for treated firms that are ex ante more likely to experience financial distress due to the frictions in three distinct markets: (i) firms facing more intense competition in product market (Valta, 2012; Zhdanov, 2007), (ii) firms depending more heavily on skilled workers in labor market (Belo et al., 2017; Ghaly et al., 2017), and (iii) firms having greater financial constraints in financial market (Livdan et al., 2009; He and Ren, 2017). Thus, our evidence is consistent with greater employer's bargaining power over labor unions significantly decreasing firm distress risk and hence encouraging innovation activities. Consistent with the findings on innovation outputs, we also find that following the headquarter-state RTW adoption, treated firms invest significantly more in R&D expenditures as an input to their improved innovation activities. Relative to control firms located in non-RTW states, treated firms on average increase their R&D expenses as a share of sales by 25.8% following the RTW adoption. We further explore a potential innovation-productivity-improvement channel behind the positive RTW treatment effect on corporate innovation outputs. As suggested by Bradley et al. (2017), unionizing the workforce can decrease wage inequality (i.e., hard work is not rewarded) and encourage shirking. Since the RTW laws weaken the unions, we expect that hard work is more likely to be rewarded with higher wages and the shirking behavior among innovative employees will decrease, leading to greater innovation productivity. Consistent with this innovation-productivity-improvement explanation, we find that the adoption of the RTW signficantly improves innovation productivity (as reflected in higher future innovation outputs per million R&D dollar input), and we observe a larger increase in innovation outputs for those firms with lower-than-median ex-ante innovation productivity (since such firms have larger room for improvement). Finally, likely due to the increased innovation activities of treated firms, we also document a significantly positive treatment effect of the RTW on these firms' competitiveness as evidenced by their gains in sales growth and market share growth from product market rivals. Our empirical evidence suggests that following the RTW adoption, treated firms on average seize 3.8% sales growth rate from industry rivals located in the non-RTW states. Our paper contributes to the finance and innovation literature (e.g., Atanassov, 2016; Brav et al., 2018; Chemmanur et al., 2014; Cornaggia et al., 2015; Moshirian et al., 2021; Tian and Wang, 2014). For example, Chemmanur et al. (2014) find that corporate venture capital differs from independent venture capital in nurturing innovation in entrepreneurial firms. Tian and Wang (2014) show that initial public offering (IPO) firms backed by more failure-tolerant venture capital (VC) investors are significantly more innovative. Cornaggia et al. (2015) find that banking competition reduces the innovation outputs of public firms but increase the innovation outputs of private firms that are dependent on external bank finance. Atanassov (2016) shows that firms that rely more on arm's length financing are more innovative than firms that use relationship-based bank financing. Brav et al. (2018) document that hedge fund activism improves targeted firms' corporate innovation. Moshirian et al. (2021) show that stock market liberalization encourages technological innovation. We add to this literature by showing that the reduction in financial distress risk because of the RTW enactment allows treated firms to conduct innovation activities more freely, leading to an increase in innovation outputs. Moreover, our paper is related to the broad labor laws and finance literature (e.g., Agrawal and Matsa, 2013; Klasa et al., 2018; Matsa, 2010; Qiu and Wang, 2018; Serfling, 2016; Simintzi et al., 2015) and, in particular, to the literature on the economic impacts of the RTW laws (e.g., Chava et al., 2020; Ellwood and Fine, 1987; Makridis, 2019). Chava et al. (2020) find that the RTW leads to lower wage growth at the state level and leads treated firms to decrease leverage and increase employment, capital expenditure and profitability. Ellwood and Fine (1987) document a significant and permanent post-RTW reduction in unionization. Makridis (2019) shows that the RTW leads to more competition among unions, resulting in an improvement in life satisfaction and economic sentiment of union workers. We contribute to this literature by providing novel evidence that the enactment of the RTW laws strongly motivate corporate managers to engage in innovation activities and enhance their firms' competitiveness. Finally, our study also contributes to the literature on labor and innovation (e.g., Acemoglu, 2010; Acharya et al., 2013, Acharya et al., 2014; Bradley et al., 2017). Acemoglu (2010) shows that labor scarcity encourages technology innovations if technology is strongly labor saving. Exploiting country-level changes in dismissal laws, Acharya et al. (2013) find that more stringent dismissal laws foster innovation particularly in innovation-intensive industries, while Acharya et al. (2014) show that the staggered adoption of wrongful discharge laws across U.S. states spurs innovation and new firm creation by limiting employers' ability to hold up innovating employees after the innovation is successful. Our paper is closely related to Bradley et al. (2017), who examine the effect of unionization on firm innovation. Using a regression discontinuity design that relies on “locally” exogenous variation in unionization generated by elections that pass or fail by a small margin of votes, the authors show that passing a union election results in an 8.7% (12.5%) decline in patent quantity (quality) three years after the election. Our findings on the impact of RTW laws on innovation are consistent with their findings, albeit we use a longer sample period and examine the impact of state-level legal changes that affect the negotiation and formation power of labor unions. Besides documenting a significant effect of the RTW laws on corporate innovations, we further document significant treatment effects on firm distress risk and product market outcomes. In sum, our evidence points toward the bright side of the RTW recognition and contributes to the debate around the real effects of these controversial laws on corporate behavior. The remainder of the paper is organized as follows. Section 2 develops the hypothesis that helps guide our empirical analysis. Section 3 describes the data and variable constructions. Section 4 presents the empirical results. Section 5 concludes. The Appendix provides the definitions of all variables used in the study and their data sources as well as additional empirical results.