Organizational Downsizing: Its Effect on Financial Performance over Time

Abstract

Traditionally, continuous growth in workforce size is a desired outcome. Downsizing within this context can be construed as a sign of organizational weakness. There is general agreement among scholars that firm performance is an important factor in downsizing decisions, with performance declines often resulting in workforce reductions (cf. Ahmadjian and Robinson, 2001; Hillier et al., 2006; Kang and Shivdasani, 1997). Recently, downsizing also has been adopted by organizations as a business strategy (e.g., rightsizing) to create flexible and nimble systems in response to increased environmental complexity and uncertainty (Mische, 2001). Consequently, the number of firms implementing downsizing has increased markedly during the past two decades. It has been estimated that roughly 2,000 employees were downsized in American corporations each business day throughout the 1990s (De Meuse and Marks, 2003). According to the United States (U.S.) Department of Labor (2011), this number rose to more than 4,000 employees each business day between 2000 and 2007. And certainly, layoffs have increased substantially during the past few years of economic difficulty not only in America but around the globe. Despite its pervasiveness, the number of academic journal articles devoted to organizational downsizing remains relatively limited and the literature is fragmented (Datta et at., 2010; De Meuse et al., 2011). In the spirit of promoting and educating executives to practice evidence-based management (Pfeifer and Sutton, 2006), several researchers have investigated the effectiveness of downsizing (Cascio et al., 1997; Cascio and Young, 2003; De Meuse et al., 1994; De Meuse et al., 2004; Sheaffer et al., 2009). While detrimental effects of downsizing have been found in most of these studies, researchers also have pointed out that the findings are confounded by other factors (Guthrie and Datta, 2008), and that downsizing might result in different outcomes in different situations. For example, Cascio et al. (1997) and De Meuse et al. (2004) have observed that the size of layoff affects financial outcomes. Trevor and Nyberg (2008) found that various human resources practices moderated voluntary turnover rates following downsizing. The purpose of the present study is to investigate the longitudinal effects of downsizing during a period of economic prosperity. Thus, the impact of one of the main factors of firm performance--the economy--is minimized. REVIEW OF THE THEORETICAL AND EMPIRICAL LITERATURE There are two primary theoretical approaches that can help explain the impact of downsizing on individuals and organizations (De Meuse et al., 2011). One approach is referred to as Contract Theory, the other is called Economic Theory. Psychological Contract Theory Psychological Contract Theory centers on the individual and posits that a mutual relationship based on trust and predictability evolves between employees and employers. According to this informal code, employees are expected to do a fair day's work and in return receive a fair day's pay (De Meuse and Tornow, 1990; Rousseau, 1995). Downsizing is a violation of this trust and the organization's responsibility to provide a positive work environment and secure employment (De Meuse et al., 2004; Morrison and Robinson, 1997). Consequently, it can lead to a number of adverse effects as employees react to such a unilateral breach. The psychological contract literature proposes that employees may reduce their organizational contributions (e.g., motivation, engagement, loyalty) and/or cause them to avoid executing tasks that will benefit organizational goals (e.g., performing at a high level or initiating organizational citizenship behaviors). In rare cases, employees might engage in theft, sabotage, or other counterproductive behaviors (Buono, 2003). Downsizing also can lead to many other negative outcomes, such as lower creativity and reduced job involvement and organizational commitment among employees (Allen et al, 2001; Luthans and Sommer, 1999; Probst et al. …

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