Academic journal article Quarterly Journal of Business and Economics

Information Asymmetries, Managerial Ownership, and the Impact of Layoff Announcements on Shareholder Wealth

Academic journal article Quarterly Journal of Business and Economics

Information Asymmetries, Managerial Ownership, and the Impact of Layoff Announcements on Shareholder Wealth

Article excerpt

Introduction

Corporate downsizing and reorganization have been common occurrences in the U.S. economy since the mid-1980s. Companies have reduced their workforces in large numbers and continue to do so. The article "Economic Beat" in Barron 's (November 8, 1999, pp. 52-53) states that the declining layoff rate during the 1990s may be misleading. The Barron's article argues that by separating cyclical trends from long-term trends, layoffs are actually occurring at a relatively higher rate compared to the overall level of unemployment during the 1990s.

The research literature in corporate finance has focused increasingly on downsizing strategies used by corporations, including mergers, selloffs, and layoffs. While downsizing appears to enhance the viability of some companies, there is considerable debate as to whether downsizing enhances shareholder wealth. The purpose of the study is to examine the information effects of one downsizing strategy--the layoff--and to test for differences in the share price responses based on the managerial ownership level, layoff magnitude, and firm size.

Layoff Evidence and Development of Hypotheses

Previous studies examining the impact of layoff announcements indicate that the announcement of a layoff has a significant impact on a company's common stock price, but the evidence regarding the direction of the share price response and the information contained in such announcements is mixed. Abowd, Milkovich, and Hannon (1990) find inconclusive results, with mixed share price responses to layoff announcements in the 1980s that are statistically insignificant.' In contrast, Worrell, Davidson, and Sharma (1991), Lin and Rozeff (1993), Chadwell and Filbeck (1994), and Pouder, Cantrell, and Kulkarni (1999) find a significant, negative share price response to layoff announcements, indicating that layoff announcements reveal troubling new information about the expected cash flows from investment opportunities and the financial status of the firm. (2)

The impact of layoffs has also been studied on the international front. Ursel and Armstrong-Stassen (1995) and Gunderson, Verma, and Verma (1997) find similar negative results with layoffs announced by Canadian firms. Lee (1997) compares market reaction to layoffs in Japan and the U.S.. She finds that layoff announcements result in negative share price responses in both countries. Announcements of permanent layoffs produce a statistically negative share price response, while temporary layoffs result in a statistically insignificant positive share price response. The difference in share price responses to these layoff announcements may be due to the size of layoffs employed. Kang and Shivdasani (1997) point out that layoffs affect a smaller fraction of the Japanese work force.

The studies cited above and others discussed below also examine various factors that may affect the sign and magnitude of the share price reaction. Factors that are found to have a significant impact on the effect of the layoff announcement include the relative size of layoffs, the industry of the company, and the nature of the layoff (e.g., permanent or temporary). Palmon, Sun, and Tang (1997) find that the reason stated by management for the layoff is the determining factor in the share price response to layoff announcements. Statistically negative returns are associated with the declining-demand subsample and with firms not stating a reason for the layoff in their announcement. Statistically positive returns are associated with the efficiency-enhancing subsample. Farber and Hallock (1999), using a sample of layoffs occurring between 1990 and 1997, find that the distribution of stock market reactions has become less negative over time. They believe one explanation for this trend is the efficiency-enhancing layoffs are becoming more common compared to those motivated by declining demand.

The long-range implications of layoffs to the bottom line negatively impact the initiating firm. …

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