I’ve received a few inquiries about layoffs and future financial performance. Several years ago I did research in this area and my general findings were that layoffs tended to have more negative than positive results. The real driver of a link between layoffs and future firm performance is found in management reaction to the layoffs as well as in the way in which the layoffs are implemented. My general rule was to avoid investing in companies which layoff more than 5% of their workforce in a given year. Such large scale layoffs introduce a complex array of firm level risk. It is often wise to wait and see how well executives manage that risk before jumping in as an investor. In today’s recessionary environment, I would consider shifting that rule of thumb up to 10% of the workforce but I’d still be wary of any large scale layoffs.
In a study of Fortune 500 firms, Peter Chalos & Charles Chen (Journal of Business Finance & Accounting, 2002) found evidence that different types of downsizing strategies have different performance implications. Layoffs related to plant closing led to slightly negative market reactions, layoffs related to cost cutting (renengineering processes, aligning cost structures with market realities, etc.) did not show a significant market reaction, while layoffs related to revenue refocusing (dropping underperforming or unrelated product lines) led to positive market reactions.
Most public announcements of layoffs (and discussions in 10-K footnotes) state one of these 3 reasons for the layoffs. This research suggests that you can use this information as a preliminary guide when assessing impact of the layoffs on future performance. Most recently announced layoffs fit the second type of layoff, aligning cost structures with market realities. These types of layoffs are frequently industry wide events and do not reveal much firm-specific information valuable to outside investors.
In a forthcoming post, I’ll outline some ways companies can use layoffs as a springboard for strategic change.
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