Worker layoffs, shareholder wealth and operating performance in different legal environments

Abstract

The objective of this paper is to find out if the country level differences in legal protection of investors and workers have an effect on (1) the likelihood of worker layoffs, (2) the stock market reactions to layoff announcements, and (3) operating performance following layoffs. Furthermore, objective is to study how firm-specific characteristics affect the observed results. The sample countries studied in this paper show either strong investor protection combined with weak union laws, or weak investor protection combined with strong union laws.

The sample consists of manufacturing companies from six countries: Australia, Canada, France, Germany, Italy, and the United Kingdom. The accounting-based data consists of 421 firm-years at the onset of a sudden and sharp deterioration in operating performance over the period 2003 to 2009, and is used in measuring the likelihood of layoffs and operating performance following the distress year. The primary source of the accounting-based data is Worldscope. To investigate the valuation impacts, a sample of 112 layoff announcements (in English language) over the period 2003 to 2009 is collected from Lexis-Nexis. The source of the equity prices is Datastream.

The results confirm that the likelihood of large-scale layoffs is lower when investor protection is weak and union laws are strong, implying that managers base layoff decisions on the relative influence of investors and workers in order to protect their own jobs. The preventive effect of strong union laws on layoff decisions is less powerful when financial leverage is high. Controlling for firm-specific characteristics, the average share price reaction on layoff announcements is less negative when union laws are strong, indicating that the market interprets layoffs of these companies as a signal that managers are siding with investors, which however, does not carry the economic importance to outweigh the bad news about declining demand. Layoffs improve employee productivity, measured by sales per employee, only when weak investor protection and strong union laws prevail. I interpret that the inefficiencies associated with unions are being diminished in these individual companies. However, layoffs lead to no improvements in profitability, measured by EBITDA to total assets, that is weighed down by restructuring costs.