Academic journal article Journal of Private Enterprise

Downsizing: An Examination of the Consequences of Mass Layoffs

Academic journal article Journal of Private Enterprise

Downsizing: An Examination of the Consequences of Mass Layoffs

Article excerpt

The recession of the early 1990s brought "downsizing" to the vocabulary and policy discussions, but economists have had a shortage of evidence about its effects on the fundamentals of the firms. Recent papers have made event studies of the stock price and have examined the pay of top executives (Hallock ,1998; Farber and Hallock, 1999) but these have not been tied down to fundamental measures of whether the firm is more profitable afterward. As the U.S. economy slows, further news items about mass layoffs have ensured that this question remains relevant.

There have been careful studies of the fates of the workers involved (Farber, 1997), but the fates of the firms have been studied less. Apart from case studies of particular companies, we don't know, in general, the effects kyoffs have on the financial health of a company. Are the few studies of "dumbsizing" representative?

This paper examines mass layoffs made by U.S. companies in the 1990s as a group to determine commonalities. By examining large kyoffs at large companies, this study will draw conclusions not from isolated incidents but from the general population. By matching kyoff announcements to financial records from Compustat on publicly traded firms, this study is able to answer questions about the effects of kyoffs upon observed measures of the firms' performance. By examining earnings, sales, and profitability of these kyoff firms, and comparing them with similar firms that did not undergo such restructuring, a broader understanding of the role of these kyoffs is achieved.

Controlling for the trend of past profitability reveals a positive marginal impact of layoffs on company profitability that strengthens over two years and persists up to four years. While profitability does fall at a typical company that has recently undergone layoffs, this does not mean that mass layoffs cause low profits. Prior declines in profitability are themselves good predictors of future layoffs. This explains the otherwise-puzzling regularity of increasing stock prices with layoff announcements during profit declines: layoffs are forecasting future increases.

Section II describes the selection of these layoff companies: how the sample was constructed, the layoffs that are in it, the dating of the layoffs, and the construction of a control group. Section III discusses the time path of profitability after kyoffs, to demonstrate that any reasonable set of controls indicates a significantly positive impact of kyoffs on profitability. Section IV assesses the predictability of the layoff decision to show that prior profitability has some predictive ability on kyoffs. Section V concludes.

Selection of companies

Since a dataset combining mass kyoff events with financial information did not previously exist, the first item of research is to gather together these separate items. As typical of event studies, companies that had large kyoffs in the period 1990-95 are selected based on articles in the Wall Street Journal. These companies are matched with financial data describing their profitability and financial status.

Construction of dataset

The Wall Street Journal Index, published at the end of each year, was used to gather articles under the keyword "kyoffs" in the years 1990 to 1995. Although previous studies worried that some kyoffs may not be publicized, the Worker Adjustment and Retraining Notification (WARN) Act, passed by Congress in 1988, requires employers to give notice to employees and local governments at least 60 days before pknt closings or mass kyoffs.

There are of course problems with using the Wall Street Journal Index to identify the sample. The coverage of WSJ articles is biased. While it may be presumed that the popuktion of large kyoffs at large companies is covered, smaller layoffs may be unevenly covered (Thompson, Olsen, and Dietrich 1987). This method of selecting the (non-random) sample has offsetting advantages: it follows the methodology of previous studies (e. …

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