· 2 min read · Features

Downsizing in a downturn – does acting fast help you in the long run? Part two

Published:

Looking at downsizing and upsizing we focus on two important questions. One, are the antecedents of restructuring common across downsizing and upsizing? And two, are the performance consequences of such restructuring related to prior firm performance?

This is part two of a two-part feature published in the HR magazine's September/October 2021 issue. Catch up on part one here.

In summary, company performance and managerial foresight appear to be the most important factors explaining either upsizing or downsizing. The economy is also an important factor followed by political risk and industry competition. Technology plays a modest role in restructuring, more so with downsizing.


More of the latest HR research:

Strategic L&D can guide the future workforce

Does your hybrid working dream match the reality

What is your response to employee activism?

Older workers’ employability is an HRD responsibility


The costs associated with downsizing

At a general level, severance packages, legally required in some countries, can be costly and time consuming to arrange. Beyond those, a company could suffer reputational damage. 

Downsizing also involves direct and indirect costs. In addition to severance pay direct costs include, accrued vacation and sick pay, pension and benefits pay-outs, and increased voluntary turnover among those who remain.

Indirect costs include decreased morale, insecurity and decreased productivity among surviving employees, the loss of institutional knowledge, and the recruiting and employment costs associated with new hires. 

With respect to divesting assets, the time and costs incurred, in especially poorly performing businesses, or those in unattractive industries, could be substantial. Asset downsizing imposes buyer-search costs and there is no guarantee that a sale will be profitable. 

In terms of time, when divesting assets, a company must identify the business assets to be separated, decide on the type of separation, and either develop a stand-alone operating model and cost structure for that business or prepare it for sale.

 

The consequences of restructuring

Multiple post-restructuring performance measures, from market-driven measures (industry-adjusted returns), to accounting measures (Return on Assets or ROA, Industry-adjusted ROA) show that combination downsizers (i.e. those that cut assets and first and make redundancies later) experience significantly greater losses leading up to restructuring, followed by sole asset downsizers, and then by employee downsizers who only make redundancies early on in the process.

With upsizing, employee upsizers have the poorest relative performance prior to the restructuring event. Asset upsizers perform relatively better, and combination upsizers (increasing both staff and assets prior to restructure) have the best performance.

 

From research to reality 

When applying these findings in the workplace HR leaders should consider the following:

1. Before engaging in employee or asset restructuring, consider the operating environment for the six key factors: company performance, managerial foresight, the economy, political uncertainty, industry competition, and technology.

2. Avoid downsizing as a quick fix for profitability. The study showed that layoffs are the most frequently employed method of downsizing but provide the smallest payoff. It might be more appropriate to be patient in the face of deteriorating results and engage in the more demanding and comprehensive combination (employee and asset) downsizing.

3. Upsizing, on average, yields better results when the company’s performance needs improvement. We found that high-profitability upsizing does not automatically lead to better stock market performance. Why not?  Because in at least some cases, cash-rich firms will misuse their funds.

Over time, companies that resist downsizing benefit from retaining key employees and attracting new talent, which, in turn, enhances profitability.

As the economy rebounds, they do not have to incur the costs of recruiting, hiring, and training new employees. It also sends an important signal to job seekers and prospective employees when companies avoid layoffs. Companies need to see their employees as assets to be developed, not just as costs to be cut. 

Wayne F Cascio is professor emeritus at the University of Colorado and consulting editor of the Journal of International Business Studies, Arjun Chatrath is professor of finance at the University of Portland’s Pamplin School of Business and Rohan Christie-David is dean of the College of Business at Texas A&M University San Antonio.

 

This piece appears in the September/October 2021 issue of HR magazine. Subscribe now to get all the latest issues delivered to your desk.