Lay off the layoffs

Mid-month bonus

Behavioral New World

May 15, 2024

Mid-month bonus: Lay off the layoffs

In a mid-month bonus [October 15, 2023, link here], Dr. John Boudreau (his website) and I looked at the reluctance of managers to evaluate human resources (HR) as investments. We argued that cognitive biases contribute to this reluctance. In this mid-month bonus, we look at the evidence about layoffs (a specific HR decision) and firm performance.

In January 2023, Salesforce laid off about 8000 workers and there were other, less substantial layoffs that year. Google and Microsoft also laid off a significant number of workers in 2023, and layoffs in the tech sector have continued in 2024. Many reasons have been given for the layoffs: over-hiring during the pandemic, decreased demand post-pandemic, and the replacement of jobs by Artificial Intelligence (AI).

In this newsletter, we consider two questions. First, do managers make rational layoff decisions? Second, do investors react rationally to layoff announcements?

Research by Capelle-Blancard and Courderc (link) reviewed more than 40 studies of layoffs. They report that the evidence on the short-run stock price reaction is decidedly mixed. This runs contrary to the common belief that layoffs almost always cause a stock price “pop.” In what follows, we focus on the long-run effects of layoffs.

If, as we argued in our earlier post, managers do not think of human resources as investments, they might make suboptimal decisions. One commentator (link) states, “They're getting away with it because everybody is doing it. And they're getting away with it because now it's the new normal.” Doing it because everyone else is doing it is not an “investments” perspective and not a particularly good decision criterion. Rather, it is an example of “herd mentality.” We might therefore expect long-run firm performance to suffer.

Well, what does the evidence say about long-run performance? An academic study by Cascio et al. (link) looks at firm performance during the year of a layoff and two years after. The authors conclude:

 “Firms that engaged in pure employment downsizing did not show significantly higher returns than the average companies in their own industries. However, companies that combined employment downsizing with asset restructuring generated higher returns on assets and stock returns than firms in their own industries.”

(Return on assets and stock returns are two common measures of firm performance.)

Our interpretation: Some layoffs, those coupled with asset restructuring, are rational decisions. These companies are rewarded with higher profitability and stock returns, although it seems to take investors some time to catch on. Other layoffs, “pure employment downsizing,” seem to have no effect on firm performance.

What about the popular view that significant layoffs are myopic and thus lead to poor performance? A Harvard Business Review (HBR) article, “Look before you lay off” (link) cites a study by Bain & Company. The evidence:

“During the study period, companies with few or no layoffs performed significantly better than those with large numbers of layoffs. Businesses that laid off 3% or less of their workforces did just as well as companies with no layoffs at all: Both groups posted 9% share price increases, on average. By contrast, share prices remained flat in companies that let go 3% to 10% of their employees, such as Newell Rubbermaid, and prices plunged 38% among those, like Sapient and Qwest, that fired more than 10% of their workforce.”

Broadly consistent with Cascio et al. and the HBR study, Capelle-Blancard and Courderc conclude: “The reason for the layoff decision is among the most decisive factors and the market sanction will be more severe in the case of defensive layoffs (taken by firms facing difficulties) than for offensive layoffs (when they are part of a more general reorganization strategy).”

In sum: 1) layoffs do not consistently cause a short-run stock price “pop;” 2) long-run firm performance depends on the reason(s) for the layoffs; and 3) investors do not immediately appreciate the benefits of layoffs concurrent with strategic changes such as asset restructuring.

Children often use the excuse, “But everyone else was doing it!” to justify violating a rule. As parents, of course, we say “If everyone was jumping off a cliff, would you?” Following the herd is seldom a good reason for any choice, but it appears it can be particularly ill-conceived and costly for business leaders when it comes to layoffs.

When it comes to human capital, leaders often believe that it is a “soft” resource, for which there is little logic, and thus may believe that following the herd is the only available decision criterion. As we’ve seen here, there is often much more available logic and evidence-based research to enhance decisions about people and work.