Wednesday, April 25, 2007


Cutting Off Your Nose To Spite Your Face

Not so long ago, there was a truism among corporate leaders that the stock price of a company rises seven percent after a major layoff. Without fail. They may now be starting to learn that this truism is, after all, only a truism. Both Circuit City and Citigroup tried to rally their falling stock prices with recent layoffs, but without success. Circuit City's stock price fell four percent after it downsized "thirty-four hundred of its most experienced sales associates" and Citigroup's stock price remained stagnant after a decimation that cost 17,000 jobs.

According to The New Yorker, "This may have surprised the executives who had planned the cutbacks, but it shouldn’t have. Over the past decade, many academics have looked at how layoffs affect stock prices, and they’ve found that the seven-per-cent rule is bunk. Instead of rising sharply, the stock of companies that trim their workforces is likely to fall. A recent meta-study that surveyed research from several countries, covering thousands of layoff announcements, concluded that, on average, markets had 'a significantly negative' reaction to job cuts. Individual companies, of course, sometimes see stock prices jump after layoff news, but there’s no evidence that downsizing is a guaranteed hit with investors."

Sometimes CEOs forget that the people who work for them are anything but overhead. These people manufacture and distribute their products, deal with customers and vendors - they even crunch the numbers their bosses use to justify their own dismissal. The stock market has gotten wise to the fact that downsizing can just as easily damage the infrastructure of a corporation as save costs. Layoffs typically render short term gains at the expense of long term organizational health, often destroying worker morale and the capital of human experience required to keep the corporate machine running smoothly. The real benefits of owning stocks come from owning them for the long haul, over which they will tend to rise, slowly but surely - but that won't happen if short term gains compromise their future viability.

One study "looked at more than three hundred firms that downsized in the nineteen-eighties and found that three years after the layoffs the companies’ returns on assets, costs, and profit margins had not improved." Why do CEOs still fall back on downsizing? The New Yorker suggests that they do it for the same reason that folks play Powerball, or flock to Hollywood to become movie stars. They are swayed by the publicity surrounding exceptional cases where downsizing has worked wonders, ignoring the hundreds of cases where layoffs had no positive effect at all. Every CEO believes deep down that he can be the next Jack Welch as deludedly as any tone-deaf wannabe imagines he will be discovered on American Idol. Even if they know that the gains layoffs provide are strictly temporary, the average tenure of a CEO is just six years - so they are compelled to get results fast, and the bad effects of their rash decisions won't materialize until long after they have made their bundle and walked out the door. Finally, the reliance of downsizing boils down to simple conformity - a craven and unimaginative tactic to keep up with the Joneses in the office tower across the street.

If a CEO does wish to leave a long term legacy he can be proud of, downsizing is like cutting off his nose to spite his face. He will end up like Ozymandias, boasting, "Look on my works, ye mighty, and despair!" - when all he ever presided over has been reduced to dust.

"It's The Workforce, Stupid!" from The New Yorker

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