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After rapidly gaining acceptance, is downsizing due for a fall?

May 1, 2009

For more information, contact: Benjamin Haimowitz, HHaimowitz@aol.com

"On the face of it, shareholder value is the dumbest idea in the world...Your main constituencies are your employees, your customers, and your products."
--Jack Welch, March 2009
 
In the 1980s his propensity for eliminating employees earned him the nickname Neutron Jack, a reference to the neutron bomb's lethality for people but not buildings or property. With Jack Welch now ranking employees ahead of shareholders as a corporate constituency, will downsizing soon join shareholder value and other salient features of contemporary business as a casualty of the present economic crisis?
 
The question gains particular pertinence from a study in the current issue of the Academy of Management Journal which reveals that as recently as 1985 corporate downsizing had a "strongly negative" effect on a company's reputation, even among two groups as overwhelmingly pro-business as top corporate executives and stock analysts.
 
But within the next 10 years, the study finds, this effect "almost completely dissipated," and, whereas only about one fourth of the companies had downsized their workforce by 1985, almost three fourths had done so by the end of 1994.
 
By downsizing, the study's authors, E. Geoffrey Love and Matthew Kraatz of the University of Illinois, mean something that is "clearly distinct from traditional practices such as furloughs and layoffs [carried out] in response to lowered demand during business downturns." In contrast, "downsizing efforts often had a more strategic intent, aiming to 'permanently' improve companywide efficiency and effectiveness... Many downsizings were of unprecedented scope and scale, involving thousands of employees, including managers."
 
How did attitudes toward downsizing change so much within a decade? Mostly, Love and Kraatz suggest, through a shift away from viewing downsizing as a kind of character deficiency, a betrayal of a company's compact with its workers, toward a sense of downsizing as critical to American competitiveness against challenges from abroad.
 
The shift is seen particularly clearly in the effect that financial performance had on the reputation of downsizing companies. In 1985, Love and Kraatz find, "firms that downsized without apparent financial need (for instance, while performance was improving)...appeared to be particularly opportunistic and untrustworthy. In contrast, downsizing firms that were manifestly in trouble may have been partially exempted from their implied commitments to their employees, and thus less likely to incur reputational damage."
 
Thus, in 1985, a downsizing company that sustained a 4.2% decline in its annual profit could expect to have its reputational ranking drop by less than one fourth as much (all else being equal) as a downsizing firm that enjoyed a 1.4% profit increase. As a longtime Ford executive commented, "When you've just reported a $1.5 billion net loss, nobody wonders why you have to cut back." Or, as another executive put it, "The toughest thing to explain is why you see a need to trim your sails when your markets are booming."
 
A decade later, however, the difference in reputation change between two such firms would be virtually nil, with neither suffering any significant loss of reputation from downsizing.
 
The findings emerge from an analysis of the results from 1985 through 1994 of Fortune magazine's annual survey to determine the country's most admired companies. The magazine asked several thousand securities analysts and executives yearly to rate firms in the industries they covered or worked in. Respondents evaluated the 10 largest firms in their industries on eight dimensions, which were averaged into a single reputation score. Love and Kraatz focused on the rankings within each industry for all firms for which detailed survey data were available, an average of 71 firms per year.
 
In all, there were 103 downsizing events in the sample over the course of the decade. Downsizings were identified from press accounts in major media, and were included only if they affected at least one percent of employees.
 
For the entire 10-year period, the within-industry reputation of downsizing firms fell, on average, by more than two-thirds of a position. But there was an unremitting trend toward acceptance of the practice over the course of the decade, so that, whereas downsizing firms lost close to 1.4 positions within their industries in 1985, they lost only 0.3 positions in 1994.
 
Is it possible that recent economic developments will bring a reversal of that trend?
 
Says Love: Even by the standards of 1985, companies that downsize today are likely to get a pass, just because the economic pressures to shed workers are so powerful during a deep recession. What will be the effect when the economy begins to recover? Welch's comment suggests that the shareholder-value model no longer dominates business thinking to the extent it did a few years ago, and it was that model that drove the downsizing trend. Obviously, competitive pressures remain strong, but a key message of our study is that company reputations are owed not just to financial performance but to broader considerations and that moral character is prominent among them."
 
The new study, entitled "Character, Conformity, or the Bottom Line? How and Why Downsizing Affected Corporate Reputation," is in the April/May issue of the Academy of Management Journal.  This peer-reviewed publication is published every other month by the academy, which, with more than 18,000 members in 103 countries, is the largest organization in the world devoted to management research and teaching. The academy's other publications are the Academy of Management Review, Academy of Management Perspectives and Academy of Management Learning and Education.
Media Coverage:
Economist.com. What's New in the Journals. (Thursday, April 30, 2009).

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