The Upside to Downsizing: Mispricing Layoffs and Firm Value
Contrary to popular opinion, one-third of mass layoffs announced by S&P 500 firms do not result in downsizing, yet the market fails to identify this anomaly in the short-run. Therefore, I construct a real-time layoff index to predict the probability of downsizing following an announcement and show that an investment strategy, long in the bottom half of the index (Downsizing), generates an annual four-factor alpha of 6.96%. Downsizers create value in the long-run because they successfully reduce costs, increase liquidity, and improve performance. Importantly, Downsizers also ensure that managers commit to downsizing by raising additional debt prior to the announcement.
In an overlapping generations model, we show that policies restricting labor mobility present firms with an important trade-off. On the one hand, firms use monopsony power over their current employees, putting downward pressure on late-career workers' wages. On the other hand, early-career workers demand a wage premium to join the restricted sector. Due to higher labor turnover costs, firms increase capital expenditures, altering their optimal capital-labor ratio. Empirically, we confirm these findings by exploiting the statewide adoption of the inevitable disclosure doctrine (IDD), a legal doctrine intended to protect trade secrets by restricting labor mobility. Following an IDD adoption by the state's supreme court, early-career workers witness higher starting wages and faster wage growth, while late-career workers experience slower wage growth. Moreover, local firms increase capital expenditures by 3.5% and capital-labor ratio rises by 5.5%. These results are amplified in high human capital intensity industries. Finally, contrary to intent, we do not find that IDD adoptions spur investment in either R&D or growth options.
Does credit rating quality affect corporate innovation? Using exogenous variation in rating quality that arises from competition among rating agencies, we show that firms with inflated ratings issue more patents, but their patent quality, as measured by scientific and economic value, declines. We provide evidence to show that managers engage in value-reducing patenting activity to exploit a compensation structure that rewards them for the number, but not the quality, of new patents. Our results are stronger in non-technology industries, which suggests that managers strategically exploit innovation when firms do not rely on patenting for value creation.
Journal of Money, Credit, and Banking 53(8), 1969-1997
We investigate the impact of mass layoff announcements on industry rivals and find that investors perceive layoff announcements as news about industry prospects. When a layoff announcement conveys good (bad) news for the announcer, rivals on average witness a 0.51% increase (0.65% decrease) in cumulative abnormal stock returns. To explain this industry effect, we test a 'growth opportunities' channel, where rivals with greater growth opportunities are affected most by changing industry prospects, and find that these firms experience the strongest contagion effect. Alternative industry classifications and a placebo test confirm that our results are not driven by confounding factors.