the performance consequences of downsizing by large industrial firms

8/14/2019 The Performance Consequences of Downsizing by Large Industrial Firms

1/22

Strategic Management JournalStrat. Mgmt. J., 26: 10871108 (2005)

Published online in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/smj.487

REDUCING SLACK: THE PERFORMANCECONSEQUENCES OF DOWNSIZING BY LARGE

INDUSTRIAL FIRMS, 197793

E. GEOFFREY LOVE1* and NITIN NOHRIA2

1 College of Business, University of Illinois at UrbanaChampaign, Champaign,Illinois, U.S.A.2 Graduate School of Business Administration, Harvard University, Boston, Mas-sachusetts, U.S.A.

We conceptualize downsizing as an attempt to reduce organizational slack. We suggest that thedegree to which downsizing will improve firm performance will be contingent on conditionsunder which the downsizing occurs. We emphasize the level of organizational slack as animportant contingency, and also examine two other contingencies: (1) whether the scope ofthe downsizing is narrow (restricted to personnel reductions) or broad (involves organizationalredesign); and (2) if the downsizing is conducted proactively (when performance is stable orimproving) or reactively (when performance is declining). By analyzing a panel dataset ofdownsizings conducted by the 100 largest American industrial firms from 1977 to 1993, we

find broad support for our hypotheses that downsizings are more likely to lead to improvedperformance when firms have high slack, when their scope of the downsizing is broad, and whenthe downsizing is done proactively. We also explore and find evidence for interactions amongthese contingencies. We discuss the implications of our findings for the literatures on downsizingand organizational slack. In doing so, we bring together two literatures that have an obviousaffinity but have been only loosely coupled in the past. Copyright 2005 John Wiley & Sons,Ltd.

Weve gotten fatthe chief executive intonesto his intimates too damn fat. Layers and lay-ers of people clogging up the corporate arteries,occluding us with bureaucracy. The Japanese arecrawling all over our customers, we cant makeany money, and the security analysts are scream-ing about our overhead. Weve got to cut back,men, trim down, eliminate people. Just the fat,mind you, no muscle. Well make ourselves likeone of those excellent companiesclose to thecustomer, zilch corporate staff, lean, baby, andmean.

(Introduction to Fortune article, July 22, 1985).

Keywords: organizational slack; downsizing; firmperformance; organizational change*Correspondence to: E. Geoffrey Love, College of Business,University of Illinois at Urbana Champaign, Wohlers Hall 219,Champaign, IL 61820, U.S.A. E-mail: [email protected]

INTRODUCTION

Downsizing has been a major and controver-

sial organizational trend since the early 1980s.

As dramatized by the opening quote, a promi-

nent rationale for downsizing has been that large

industrial firms are fatthat is, they are ineffi-

cient and the necessary outputs can be produced

with fewer resources (Thurow, 1986; Caves et al.,

1993; Baumol, Blinder, and Wolff, 2003). Down-

sizings can be conceptualized, then, as attempts

to improve performance by reducing organiza-

tional slackthat is, resources in excess of those

required to produce necessary outputs (Cyert and

March, 1963; Bourgeois, 1981).

Whether downsizings actually improve firm

performance has been a central question in the

downsizing literature, with studies reporting mixed

Copyright 2005 John Wiley & Sons, Ltd. Received 28 December 1999Final revision received 8 April 2005


2/22

1088 E. G. Love and N. Nohria

results (e.g., Worrell, Davidson, and Sharma, 1991;

Cameron, Freeman, and Mishra, 1993; Caves

et al., 1993; Cascio, Young, and Morris, 1997; Lee,1997; Palmon, Sun, and Tang, 1997; Espahbodi,

John, and Vasudevan, 2000; Baumol et al., 2003;

Chadwick, Hunter, and Walston, 2004). These and

other studies have also investigated how various

characteristics of downsizings or of downsizing

firms influence the success of downsizings.

However, while some researchers have raised

concerns that downsizing may leave firms with

too little slack (e.g., Lawson, 2001; Cascio and

Young, 2003), the relationship between the level

of slack and performance improvements following

downsizing has not been systematically examined(though see Caves et al., 1993). This constitutes

an important gap, given the prominent role of

fat and (often implicitly) slack in discussions of

downsizing.

The present study takes a step to address this

gap, by assessing whether downsizings are more

likely to improve firm performance when firms

have greater slack. The study also contributes to

the literature on downsizing by examining how

downsizings success is influenced by two other

important contingencies: (1) the degree to which

downsizings are coupled with broader organiza-tional redesign (Cameron et al., 1993; Freeman,

1999; Marks, 2003), which we refer to as the

scope of the downsizing; and (2) whether down-

sizings are proactive or reactive (Lee, 1997; Marks

and De Meuse, 2003), which we refer to as the

timing of the downsizing. Both contingencies are

recognized as important within the downsizing lit-

erature, but empirical evidence on how they affect

post-downsizing firm performance is limited. The

study contributes to the literature on slack as well.

Researchers have debated how slack affects orga-

nizational performance. On the one hand, slack orfat has been equated with inefficiency by agency

theorists, who argue managers accrete slack and

misuse it because of agency problems (Jensen and

Meckling, 1976; Jensen, 1993). Organization the-

orists, in contrast, have argued that slack serves

several useful functions (Cyert and March, 1963;

Bourgeois, 1981; Singh, 1986), so attempts to

reduce slack may be ill advised (Lawson, 2001).

In attempts to resolve this debate, researchers

have examined how levels of slack affect differ-

ent dimensions of firm performance (e.g., Nohria

and Gulati, 1996; see Tan and Peng, 2003, for

a review). We add a new dimension, by investi-

gating how the initial level of slack affects the

success of slack reduction efforts. Additionally,studying downsizing can inform research on slack

because downsizing attempts to reduce absorbed

slack (Bourgeois, 1981)slack that is enmeshed

in a firms operations, such as personnel. Reduc-

ing such slack is held to be more difficult than

reducing other, more flexible forms of slack such

as retained earnings (Bourgeois, 1981; Wiseman

and Bromiley, 1996). However, the slack literature

itself has not addressed whether, how, and when

efforts to reduce absorbed slack are most likely to

be successful.

Below, we first develop conceptual links be-tween research on downsizing and on slack, two

literatures that need to be more tightly connected.

We then develop hypotheses regarding how

absorbed slack and the two other contingencies

(scope and timing) will affect post-downsizing per-

formance.

THEORY AND HYPOTHESES

Downsizing and slack

Downsizing is often defined as an intentional

effort to permanently reduce personnel in order to

improve organizational efficiency and/or effective-

ness (Cameron et al., 1993; Freeman and Cameron,

1993). This definition implies the existence of

excess, removable personnel and suggests that the

practice can be conceptualized as an attempt to

reduce slack. Of course, slack itself encompasses

more than excess personnelexcess resources that

may constitute slack range from retained earnings

to excess inventory, working capital and person-

nel (Cyert and March, 1963; Bourgeois, 1981).

Because the concept is so broad, researchers have

categorized slack into different types, dependingon ease of recovery or redeployment. The most

common such categorization is between absorbed

and available (or unabsorbed) slack (see Bour-

geois and Singh, 1983; Singh, 1986; Sharfman

et al., 1988). Available slack, such as retained

earnings, is highly flexible and easily redeployed.

In contrast, absorbed slack is not easily redeployed.

Excess personnel are an ideal example of absorbed

slack, as they may be excess but are also embedded

in the organization through allocation to specific

routines and tasks. Working capital tied up in oper-

ations is another example of absorbed slack, as

Copyright 2005 John Wiley & Sons, Ltd. Strat. Mgmt. J., 26: 10871108 (2005)


3/22

Reducing Slack 1089

recovering it could require changes to established

routines and affect customer and supplier relation-

ships. More specifically, then, downsizings aim toreduce absorbed slack and transform it to avail-

able slack through cost savings and increased cash

flow.

For the panel of firms we studied, broad his-

torical trends supported a view that levels of

absorbed slack were excessive that large U.S.

industrial firms had become fat through the

1970s and early 1980s (Tomasko, 1987; Caves

et al., 1993). For example, in 1970, 25 percent of

manufacturing employees were in non-production

jobs (managers, support staff, overhead), but that

figure increased to 30 percent in 1980 and 32percent in 1985, remaining steady at that level

through the 1990s (Bureau of Labor Statistics,

2003). After the oil shocks of the 1970s, the suc-

cess of foreign competitors led to assessments

that the cost structures of U.S. firms, especially

their overhead costs, were too high (Thurow,

1986; Tomasko, 1987; see also Baumol et al.,

2003). U.S. industrial firms responded in sev-

eral ways, particularly through permanent per-

sonnel reductions downsizings. Downsizing was

widespread, with Fortune 100 firms announcing

reductions of over five million employees between

1978 and 1999 (Nohria, Dyer, and Dalzell, 2002).

Firms initially downsized in reaction to perfor-

mance declines, but as the practice became widely

accepted firms that were performing well also

downsized (McKinley, Sanchez, and Schick, 1995;

McKinley, Mone, and Barker, 1998). Many down-

sizings targeted management and white-collar staff

outside the firms productive core (Heckscher,

1995), areas where proponents of the slack-as-

inefficiency view suggest slack resources are espe-

cially likely to accrete (Williamson, 1963, 1964).

Notwithstanding the apparently high levels of

absorbed slack, improving firm performancethrough downsizing was difficult. Most downsizing

organizations did not meet their cost-savings and

other efficiency-improvement expectations (Amer-

ican Management Association, 1993; Conference

Board, 1993; Cameron et al., 1993). Indeed, there

is considerable debate around the central ques-

tion of whether downsizing, on average, improved

performance at all. Empirical studies of post-

downsizing firm performance report mixed results.

For example, De Meuse, Vanderheiden, and

Bergmann (1994, 1999) and Palmon et al. (1997)

find a negative main effect of downsizing on firm

performance, while Cascio et al. (1997) find no

main effect. Other studies find instead that down-

sizers improved performance, increased efficiencyand reduced costs (Espahbodi et al., 2000; Wayhan

and Werner, 2000; Baumol et al., 2003). Several

additional studies find negative short-term stock

price reactions to downsizing announcements (e.g.,

Worrell et al., 1991; Caves et al., 1993; Lee, 1997;

Palmon et al., 1997; Franz, Crawford, and Dwyer,

1998).1 Differences between these findings have

been attributed to differences in measures, method-

ologies, and time periods being studied (Wayhan

and Werner, 2000).

Researchers have also found evidence that a

number of contingencies affected the success ofdownsizings. For example, downsizings in res-

ponse to demand declines have been associated

with more negative returns than those done for

efficiency improvement (Palmon et al., 1997), and

trust in management, planning, and careful imple-

mentation have been associated with better down-

sizing performance (Cameron et al., 1993). As

mentioned earlier, however, slack itself has receiv-

ed little attention as an important contingency,

notwithstanding frequent references to fat in the

rhetoric around downsizing.

Research on organizational processes associated

with downsizing often resonate with research onslack itself, and provide further evidence of the

potential value of research that links the two liter-

atures. For example, downsizing firms are reported

to have rehired employees they had laid off, after

it became evident that the employees possessed

critical specific or tacit knowledge (Buono, 2003).

This resonates with arguments that absorbed slack

is difficult to identify (Jensen and Meckling, 1976;

Caves et al., 1993; Bourgeois and Singh, 1983).

Other studies indicate that downsizing damages

communication and learning networks (Doughtery

and Bowman, 1995; Fisher and White, 2000)and leads to confusion as to who is in charge

(Marks and De Meuse, 2003). These findings are

consistent with the idea that reducing absorbed

slack is difficult because the slack resources are

1 Researchers (see McWilliams and Siegel, 1997; Caves et al.,1993) caution that short-term stock price changes may not beunbiased estimates of the expected longer-term performanceimpact of an announced action. For example, market partici-pants may bid a stock down because they interpret a downsizingannouncement as a signal of poor prospects ahead, quite indepen-dent of whether they believe the downsizing itself will improvematterswhat has been termed the bad news effect (Caveset al., 1993).



4/22


themselves enmeshed in organizational processes

(Bourgeois and Singh, 1983; Mone, McKinley,

and Barker, 1998). Finally, marked similarities areevident between the functions attributed to slack

and post-downsizing problems in organizations.

Researchers stress that slack can facilitate adapta-

tion, innovation, creativity and risk-taking by pro-

viding resources for search and experimentation,

and can also facilitate decision-making by provid-

ing resources that allow resolution of goal conflict

between competing factions (Cyert and March,

1963; Levinthal and March, 1981; Bourgeois,

1981; Singh, 1986; Zajac, Golden, and Shortell,

1991; Lawson, 2001). Studies of firms that down-

sized have found problems in each of these areas:downsizing can reduce organizational adaptability

and flexibility (Fisher and White, 2000; Cascio

and Young, 2003), reduce innovation (Doughtery

and Bowman, 1995; Lawson, 2001), reduce cre-

ativity (Amabile and Conti, 1999), reduce risk-

taking (Cameron et al., 1993), and increase polit-

ical behavior (Marks and De Meuse, 2003). Of

course, many other consequences of downsizing

seem less related to slack, such as the practices

negative effects on employee confidence, morale,

commitment, and perceptions of the organization

and management (Brockner et al., 1987; Noer,

1993, 1997; De Meuse, Bergmann, and Lester,

2001; Marks, 2003). Taken together, however, the

parallels between organizational processes associ-

ated with downsizing and research on slack further

suggest the potential value of considering slack

when assessing the success of downsizings.

Slack and performance improvements from

downsizing

The foregoing discussion calls attention to several

ways that slack, downsizing, and post-downsizing

firm performance may be interrelated. The firmswere fat rationale often advanced to justify down-

sizings implies one such relationship: that down-

sizing will improve performance most at firms that

are particularly fat (i.e., firms that have high

absorbed slack).

Theorists on both sides of the debate about

slacks functionality have advanced arguments

consistent with this intuitive proposition. Under-

lying positive views of slack held by organiza-

tion theorists (Cyert and March, 1963) is a belief

that there is an optimal level of slack (Sharfman

et al., 1988), as potential costs of excessively high

slack are recognized even while adaptive functions

of slack are emphasized (Tan and Peng, 2003).

Researchers have thus predicted and found evi-dence that the relationship between levels of slack

and performance is an inverted U-shape (Bour-

geois, 1981; Nohria and Gulati, 1996; Tan and

Peng, 2003). This suggests slack reductions at

firms above the optimal point those with high

slack would improve performance. Conversely,

reductions at firms below the optimal point would

hurt performance.

Agency theorists and organizational economists

take a different view, identifying slack with inef-

ficiency (Williamson, 1963, 1964; Leibenstein,

1966, 1980; Jensen and Meckling, 1976). Theyargue slack is accumulated and misused because of

principalagent problems. Particularly when man-

agerial tasks are difficult to monitor and control

based on output, managers often are able to accu-

mulate excess resources. Managers then use such

slack resources to further their own interests, for

example by empire-building, engaging in unprof-

itable diversification or R&D projects, delaying

exit, or padding budgets (Williamson, 1963, 1964;

Jensen, 1986, 1993; Dunk and Nouri, 1998). In

this view, the optimal level of slack would seem

to be zero. However, slack is impossible to elim-

inate entirely as it is often not visible to princi-

pals agency theorists hold not only that man-

agers will accrete slack, but also that they will be

loath to reveal it (Caves et al., 1993). Research on

downsizing similarly finds that identifying excess

personnel (and thus reducing absorbed slack) is

difficult (e.g., Buono, 2003). Bringing these points

together, it seems logical that the higher the level

of absorbed slack, the more likely some such slack

will be identifiable and productively recoverable.

Both perspectives on slack thus suggest that:

Hypothesis 1: Performance changes followingdownsizings will be positively related to the

firms prior level of absorbed slack.

Narrowly and broadly scoped downsizings

We next ask how firms approaches to implement-

ing downsizing affects the success of those efforts,

which bears on the broader question of how firms

can best recover absorbed slack. Firms approaches

to implementing downsizing have varied consid-

erably, with an important dimension of variation

being the range of organizational elements affected



5/22

Reducing Slack 1091

(Freeman and Cameron, 1993; Freeman, 1999). We

refer to this dimension as the scope of the down-

sizing. Some downsizings are of narrow scope,focusing almost exclusively on the single key

dimension of reducing personnelfor example a

cost-cutting, across-the-board lay-off which incor-

porates few other changes. At the other end of

the spectrum are downsizings of broad scope. In

addition to reducing personnel, significant organi-

zational redesign is an important goal and changes

in systems, structure, and/or strategy are sought

(see Freeman, 1999).

The underlying premise of narrowly scoped

downsizings is captured by the metaphor of cut-

ting fat. That is, the firm is fat, so there areexcess personnel that can be readily identified and

then removed (cut) without undue disruption to

the main body (firm). Narrow-scope downsizings

are reportedly the most common type (Cameron

et al., 1993).

However, several arguments suggest that the

premise of narrowly scoped downsizings is often

flawed, and broadly scoped downsizings will be

more effective. First, the definition of absorbed

slack itself suggests that removing putatively

excess employees is likely to be disruptive rather

than straightforward. Merely removing employ-ees as in narrow downsizings reduces costs, but

may also throw the organization out of internal

alignment (Lawrence and Lorsch, 1967; Nadler

and Tushman, 1997) through a mismatch of the

remaining personnels skills, knowledge, and net-

works with the needs of existing structures and

systems (Fisher and White, 2000; Buono, 2003).

For example, we know that some organizations

have had to rehire (at high cost) employees that

were cut but turned out to have crucial knowledge

or skills (Cascio, 1993; Buono, 2003). Second,

absorbed slack resources such as employees areembedded in inertial, difficult-to-change organiza-

tional routines and processes (Nelson and Winter,

1982; Hannan and Freeman, 1984). Downsizings

that focus solely on reducing personnel may lead

to survivors making only local adjustments, as they

attempt to perform the same routines and processes

(Freeman, 1999; Marks, 2003). This may leave

survivors in an unsustainable position, at risk of

overwork or burn-out (Noer, 1993; Marks and

De Meuse, 2003). Downsizings focused only on

workforce reduction may also be more susceptible

to implementation problems (Cameron, 1994).

A more broadly scoped approach can lead to

wider-ranging adjustments for example, when

revisions in processes, systems, and structureseliminate outdated or redundant tasks and stream-

line tasks that remain (Freeman, 1999). Because

of its wider purview, such an approach can mini-

mize misalignment and other risks, and so recover

absorbed slack more effectively and sustainably.

Supporting this view, Cameron et al. (1993) found

that participants perceptions of downsizings that

included carefully planned organizational redesign

(i.e., broad scoped) were more positive than they

were for downsizings that emphasized workforce

reduction (i.e., narrow scoped). Such broader

changes can also do more than improve efficiencyby reducing costs; they also have substantial poten-

tial to increase organizational effectiveness (Free-

man and Cameron, 1993; Cameron et al., 1993;

Marks, 2003). For example, process redesign can

not only reduce the number of employees, but

can also lead to processes that are more respon-

sive to customer needs (Hammer and Champy,

1993). Reducing the number of management lay-

ers not only reduces overhead costs, but can also

improve information flows and reduce decision-

making times (Neinstedt, 1989; Marks, 2003).

These arguments together suggest:

Hypothesis 2: Broadly scoped downsizings will

be associated with better performance outcomes

than narrowly scoped downsizings will be.

Timing of slack reduction: Proactive and

reactive downsizing

Our third question asks how the success of

downsizings depends on their timing, which bears

on the broader question of when it is best to

recover absorbed slack. Specifically, we considerwhether firms do better if they initiate downsizing

reactively after performance has declined or

proactively, when performance has not declined

(Tushman and Romanelli, 1985). The firms we

studied downsized both proactively and reactively

as the practice became widespread (McKinley

et al., 1998). For example, by 1989 only 40

percent of firms cited a business downturn as a

contributing cause of downsizing and by 1995 only

6 percent of firms cited a business downturn as the

sole cause for downsizing (American Management

Association, 1989, 1995).



6/22


There is some empirical evidence on this ques-

tion of the proper timing of downsizing. Abnormal

stock market returns after downsizing announce-ments are more negative when firm performance

is poor or declining (Worrell et al., 1991; Lee,

1997)though the conclusions that can be drawn

from such event studies about longer-term perfor-

mance effects are limited (McWilliams and Siegel,

1997). While no studies we are aware of examine

longer-term returns after a performance decline,

Espahbodi et al. (2000) found that longer-term

returns at firms that were performing at low lev-

els benefited more after downsizings. As evidence

from prior studies is inconclusive, we rely on con-

ceptual arguments to formulate our hypotheses.The distinction between absorbed and avail-

able slack is again crucial to our arguments. As

already discussed, effectively removing absorbed

slack often requires changes in routines beyond

simply removing the personnel. Effective imple-

mentation of such changes requires time for new

routines to be planned, enacted and learned, as well

as dedication of resources and managerial attention

over a sustained period (Beer, Eisenstat, and Spec-

tor, 1990; Marks, 2003). Interpersonal networks

must be changed and rebuilt (Fisher and White,

2000). Indeed, Cameron and colleagues (1993) find

that the most successful downsizings are system-

atically planned, are conducted through an incre-

mental approach, and include a great deal of com-

munication with, and involvement of, employees.

Productively removing absorbed slack is thus

likely to require significant planning, time, and

resources, rather than being quickly adjustable in

a reservoir-like fashion as unabsorbed slack can

be. Moreover, a planned and consistent approach

is likely to be difficult to achieve in a reactive

situation, when performance problems create pres-

sure for rapid action (Ginzberg, 1985). Reactive

downsizings may be associated with organizationaldecline, which Cameron, Whetten, and Kim (1987)

report to be associated with such dysfunctions as

a short-term crisis mentality, resistance to change,

restricted communication, lack of teamwork, and

a rigid rather than flexible response (Staw, Sande-

lands, and Dutton, 1981). The dysfunctions fur-

ther suggest that reactive downsizers will have

difficulty devoting necessary planning, time, and

resources to the task.

One countervailing argument is that reactive

downsizings have greater legitimacy because con-

ditions are manifestly dire (Noer, 1993). Both

those laid off and those that survive are likely

to be less angry when downsizing is undertaken

reactively (Brockner et al., 1987; Noer, 1993).This argument has some face validity. However,

the secular decline in U.S. manufacturing became

increasingly evident through the 1980s (Piore and

Sabel, 1984; Nohria et al., 2002), making the need

for overhead reduction measures more evident

(Thurow, 1986) even at relatively healthy firms.

Overall, arguments for the superiority of proac-

tive action appear preponderant and thus:

Hypothesis 3: Proactive downsizings will be

associated with superior performance outcomes

in comparison to reactive downsizings.

Interaction of slack with scope and with timing

We now return to our initial question and focus

that is, how the level of absorbed slack is related

the success of downsizings. We extend the initial

proposition that downsizings in the presence of

greater absorbed slack will be more successful,

by further proposing that such slack may have

greater or lesser influence in different situations.

Specifically, we argue that the scope and timing

of downsizings will affect the degree to which the

level of absorbed slack influences the success of

downsizings.

We first propose that the firms level of absorbed

slack will affect the success of downsizings more

when the downsizings are of narrow scope than

when they are of broad scope. Our reasoning

is that the premise underlying narrowly scoped

downsizings that identifying and productively

removing excess resources is relatively straightfor-

wardseems much more likely to hold true if the

firm, in fact, is fat. In such cases, it may be that

firms can identify and remove some truly excess

resources with relatively little disruption. The con-cerns raised earlier may also be of less import; it

may not be necessary to redesign processes to sus-

tainably reduce absorbed slack or maintain orga-

nizational alignment. Moreover, narrowly scoped

downsizings seem unlikely to succeed at firms

where slack resources are scarce and so not in plain

view. For example, to satisfy a call for across-

the-board lay-offs, productive personnel in some

departments may be cut and organizational mis-

alignments will likely arise. Thus the success of

narrowly scoped downsizings will be closely tied

to the level of absorbed slack.



7/22

Reducing Slack 1093

On the other hand, the more fundamental

changes associated with broadly scoped downsiz-

ing elimination of unnecessary processes, reduc-tion of management layers, and so on suggest

success is likely to be more dependent on the qual-

ity of the redesign effort itself, and so will be

somewhat decoupled from the level of absorbed

slack. For example, proponents of reengineer-

ing claim the key to dramatic efficiency gains

lies not in incrementally eliminating fat from

existing processes, but rather in reconceptualizing

the processes themselves (Hammer and Champy,

1993). While such efforts may produce somewhat

larger gains if the initiating firm is fat, success-

ful redesign might also improve firm performanceeven if there was little apparent slack before-

hand. Thus the success of broadly scoped down-

sizings should not be as closely tied to the level of

absorbed slack. These arguments lead us to:

Hypothesis 4: Performance changes following

narrowly scoped downsizings will be influenced

more by the firms prior level of absorbed slack

than will performance changes following

broadly scoped downsizings.

We also expect that the firms level of absorbed

slack will be more important for the success of

reactive downsizings than it will be for proactive

downsizings. In a reactive situation, speed is of the

essence (Ginzberg, 1985). The success of down-

sizings will then hinge on whether slack is easily

observable and removable. This is likely, in turn,

to depend on the level of absorbed slack itself. If

there are considerable excess resources, then even

a hasty downsizing effort is likely to have some

success finding and cutting this fat. If, on the

other hand, there is little absorbed slack, a rough-

and-ready downsizing is likely to cause a great

deal of disruption and, moreover, pressures foraction will combine with limited resource avail-

ability to make it difficult to adjust in response.

With a proactive downsizing, in contrast, even in a

low-absorbed slack situation there is time to ferret

out where slack really is and adjust to problems

as they develop (Marks, 2003). The relationship

between the level of absorbed slack and the suc-

cess of the downsizing is thus likely to be weaker

in the proactive case. Accordingly we hypothesize:

Hypothesis 5: Performance changes following

reactive downsizings will be more influenced by

the firms prior level of absorbed slack than per-

formance changes following proactive downsiz-

ings will be.

METHODS

Sample

The study used a panel of the 100 largest indus-

trial firms in the United States in 1977, as ranked

by Fortune magazine. Large firms such as these

are of substantive interest because they comprise

the industrial core of U.S. firms and, as such,

have attracted considerable attention from orga-

nizational scholars (e.g., Fligstein, 1990; Davis,

1991; Nohria et al., 2002). Further, large indus-

trial firms were most affected by the downsizing

trend (Baumol et al., 2003) and allegations of high

overhead costs were especially focused on them

(Thurow, 1986). Large firms also receive exten-

sive media coverage (Fombrun, 1996), which has

the advantage of decreasing the likelihood of unre-

ported downsizings.

The study period was from 1977 to 1993, which

covers the period from the start of the down-

sizing trend after the second oil shock (Love,

2000) through to widespread use of the prac-tice (McKinley et al., 1995). The study period

includes recessionary and expansionary periods,

which is advantageous as post-downsizing perfor-

mance may depend on macro-economic conditions

(Wayhan and Werner, 2000).

We used pooled time-series analysis, with the

unit of analysis the firm-year. This technique

is advantageous because it allows assessment of

whether the independent variables differentially

influence firm performance in post-downsizing

firm-years, as compared to other firm-years. The

dataset thus includes all firm-years during the studyperiod for which financial information was avail-

able, for a total of 1367 firm-years. Financial

data were from Compustat unless noted. Industry

boundaries were defined using 2-digit SIC codes.

Events: Downsizing announcements

Downsizings were identified using firms

announcements, as in several other studies of

downsizing (e.g., Worrell et al., 1991; Lee, 1997;

Espahbodi et al., 2000). The Lexis/Nexis elec-

tronic database records of the Wall Street Journal,



8/22


the New York Times, and several wire services

were searched. To qualify as events, announced

downsizings had to meet the definition presentedearlier. Accordingly, we did not include announce-

ments of temporary lay-offs or of pure divesti-

tures, which are conceptually distinct. Our focus

was on performance during the 3 firm-years fol-

lowing the announcement, similar to other studies

of long-term post-downsizing performance (Cascio

et al., 1997; Palmon et al., 1997; Espahbodi et al.,

2000). Potentially confounding events may occur

during such a long period, so only larger down-

sizings could be reliably expected to affect firm

performance. Thus we established a size thresh-

old of 4 percent of employment for announcementsto qualify as events. This seemed a conserva-

tive choice, given Caves et al.s (1993) finding

of no regular abnormal stock market returns for

announcements of less than 6 percent of employ-

ment.

We considered an alternative indicator of down-

sizing annual firm-level employment changes.

However, large multibusiness firms often acquire

and divest businesses, as well as hire in some

units while downsizing in others (American Man-

agement Association, 1994). Thus, we believe

announcements are the more valid indicator. We

did verify that downsizing announcements were

associated with actual employment decreases: in

this dataset, firms mean employment decreased

7.1 percent (p < 0.001) in the year of the down-

sizing announcement and a further 4.5 percent

(p < 0.001) in the year after, whereas the mean

employment change was essentially zero in other

firm-years.

We identified downsizing announcements that

met these criteria in 120 firm-years. Individual

firms sometimes announced more than one large

downsizing in a single calendar year. In these

cases, we adjusted some of the variables describedbelow: size was summed across downsizings, while

scope and employee type were assigned based on

the type that fit the majority of employees affected.

Post-downsizing firm-year indicator variable

While we identify downsizings using announce-

ments, we assess firm performance in the 3 firm-

years following the announcement. Consequently,

these post-downsizing firm-years must be distin-

guishable from other firm-years in the dataset.

To do this, we construct an indicator variable

(Downsizing in prior 3 years) that takes value one

if there was a downsizing announcement in any of

the 3 prior firm-years for the focal firm, and valuezero otherwise. For example, if a firm announces

its only downsizing in 1984, the indicator variable

would be one in 1985, 1986, and 1987 and zero in

other years, for that firm.

Dependent variables

Return on market-valued assets (ROA-Market)

and Return on book-valued assets (ROA-Book)

To assess post-downsizing performance, we used

two related measures of a firms operating per-formance.2 Return on market-valued assets (also

ROA-Market) is the annual operating income

before interest, depreciation, and special charges,

divided by the beginning-of-year market value of

equity plus the book value of long-term debt. This

measure reflects performance relative to current

and future performance expectations, because it

assesses actual returns against the market value of

the firm at the beginning of the year (see Healy,

Palepu, and Ruback, 1997, for a discussion of

the advantages of this measure). Return on book-

valued assets (also ROA-Book) is the same operat-

ing income figure divided by the end-of-year book

value of assets. This standard accounting measure

of return has been used in several studies of post-

downsizing performance (e.g., Cascio et al., 1997;

Palmon et al., 1997; Espahbodi et al., 2000). Both

measures were industry-adjusted by subtracting the

industrys mean sales-weighted return. While the

two measures are clearly related, their pair-wise

correlation is only moderate at 0.27. It is not sur-

prising that widely used firm performance mea-

sures are only modestly correlated (see Meyer,

2002), but the modest correlation will speak to

the robustness of relationships should consistentresults be found across the two measures.

2 Alternatively, the dependent variable might have been the post-downsizing change in absorbed slack. However, for this studyour interest was in downsizings impact on overall firm per-formance. We did perform preliminary analyses that verifieddownsizings were associated with slack reductions. We usedOLS regression on annual percentage changes in SG&A, con-trolling for annual percentage changes in firm sales in the yearof the downsizing and the prior year. We found that in firm-years after large downsizing announcements SG&A decreasedby 2.8 percent (t= 2.5, p < 0.015). Thus it appears large down-sizings did lead to removal of absorbed slack, as proxied bySG&A.



9/22

Reducing Slack 1095

Independent variables

Absorbed slack

We used the firms sales, general, and administra-

tive (SG&A) expenses to construct our measures

of absorbed slack. SG&A has been theorized to

vary with levels of absorbed slack and has often

been used as an indicator of slack resources chan-

neled into overhead and staff expenses (e.g., Bour-

geois, 1981; Lant, 1985; Singh, 1986; Wiseman

and Bromiley, 1996). While SG&A is the best-

established and most available measure, we do

recognize that it is only a proxy for personnel-

related absorbed slack. SG&A does not include all

such slack nor, clearly, are all SG&A expensesslack.

We used SG&A to operationalize two alternative

measures of absorbed slack. Absolute absorbed

slack is based on the argument that the higher the

overall level of absorbed slack, the more likely

some fraction of it can be productively recov-

ered. The measure is SG&A as a fraction of sales,

in the year prior to the downsizing announce-

ment. In contrast, Relative absorbed slack mea-

sures whether absorbed slack is high or low rela-

tive to similar firms. It is the firms SG&A level

(as a fraction of sales) minus the mean industrySG&A level (sales-weighted), in the year prior

to the downsizing announcement. Both measures

were positively skewed with high kurtosis (8.4 and

8.1), reflecting a few firm-years with exception-

ally high levels of absorbed slack. To compensate,

we transformed each measure by taking its natural

logarithm.3

We are interested, of course, in whether a firms

level of absorbed slack affects post-downsizing

performance. However, the level of absorbed slack

may also affect firm performance in general (Tan

and Peng, 2003). Consequently, we include absor-

bed slack in the models first as a control termto

capture any generalized effect and then more

importantly, as an interaction term with the down-

sizing indicator variable (e.g., Absolute absorbed

slack * Downsizing in prior 3 years ). The interac-

tion term is the one of interest, because it estimates

the effect of absorbed slack on firm performance

in post-downsizing years, net of the generalized

3 The results presented are similar if we use a square-roottransformation. If we use the raw figures, the results show thesame patterns but with lower levels of significance.

effect of absorbed slack as captured by the control

term.

Because the term of interest is an interaction,we centered both slack measures to simplify inter-

pretation of coefficients (Jaccard, Turrisi, and Wan,

1990). We centered each measure by subtracting its

mean level across the set of 120 firm-years prior

to downsizing announcements. In other words, the

centering is relative to our object of interest, the

average downsizing firm.

Broad or narrow scope

We assessed the scope of downsizing dichoto-

mously. We classified downsizings as broad scopewhen the announcement text indicated that employ-

ment reductions were linked with (1) structural or

process changes such as restructurings, reorgani-

zations, and process redesign, as well as reduc-

tions in the number of hierarchical levels, func-

tions, or divisions in the firm, or (2) changes in

the firms strategic domain, such as focusing on

the core business, or narrowing the product line.

The downsizing was coded as narrow scope if the

announcement showed no evidence of these types

of actions, which typically meant the announce-

ment was focused on cutting personnel costs only.

The coding was conducted independently by the

authors and by a research associate. Inter-rater reli-

ability was over 90 percent, and joint discussions

quickly led to consensus in the remaining cases.

We operationalized scope as a dummy variable,

Broad scope, which takes value one for downsiz-

ings coded as broad scope and zero otherwise. The

scope dummy appears in the models as an inter-

action term, Broad scope * Downsizing in prior

3 years, in order to allow comparison of the impact

of broad vs. narrow scope downsizings on firm

performance in post-downsizing firm-years.

Timing

Proactive or reactive timing was measured using

the change in the firms market capitalization in

the year before the downsizing. We used this mea-

sure because equity markets capture a broad range

of current and anticipated changes in the firms

performance situation (Healy et al., 1997). More

positive changes indicate stable or improving per-

formance and prospects in the period just before

the downsizing, and thus more proactive downsiz-

ings. Specifically, Timing is operationalized as the



10/22


natural logarithm of the ratio between the firms

market capitalization (market value of equity plus

long-term debt) at the end and at the beginningof the year prior to downsizing, centered as was

described in the section on absorbed slack mea-

sures. As with the absorbed slack measures, this

variable may have an effect on firm performance

in general, whereas we are specifically interested in

its differential effect on firm performance in post-

downsizing years. So as with absorbed slack, the

timing/market value change measure appears as a

control term (Market value change) to capture any

generalized effect and as an interaction term (Tim-

ing * Downsizing in prior 3 years ) to estimate the

differential effect. Again, the interaction term isthe one of interest.

Control variables

The core control variable is the lagged (i.e.,

y 1) dependent variable (ROA-Market or ROA-

Book). Besides being a powerful control for the

level of prior performance, this addresses concerns

about potential mean reversion in performance (cf.

Espahbodi et al., 2000). We also control for indus-

try, firm, and downsizing-related factors. Palmon

et al. (1997) found that the success of downsiz-

ings was impaired when product market condi-

tions were poor. Thus we control for Industry sales

change in the focal firm year. This reflects prod-

uct market conditions and controls for whether

the firms overall market is growing or shrink-

ing. The measure is the logarithm of the ratio

between inflation-adjusted industry total sales in a

particular year and inflation-adjusted industry sales

in the prior year. Cascio et al. (1997) found that

changes in assets affected the success of down-

sizings. Thus we control for Asset changes using

the logarithmic ratio of book value of assets in a

particular year compared to the prior year. Con-trols were also included for characteristics of the

downsizing itself: the size and type of employ-

ees affected (Caves et al., 1993), and whether the

firm had downsized previously (Lee, 1997). The

Size of reduction was the expected size of the

personnel reduction(s), expressed as a percentage

of total firm employment in the prior year. Pro-

duction employees captures the type of employee

affected. It is operationalized as a dummy variable

with value one for announcements that indicate

the downsizing is focused on production or blue-

collar employees, and value zero otherwise. Prior

downsizing indicates the percentage of employ-

ees affected by downsizings announced at the

focal firm in the year prior to the downsizingannouncement. This is transformed by taking its

square root in order to avoid undue influences from

firms that announce the largest downsizings. Sev-

eral of the control variables above appear in the

models as interaction terms with the Downsizing

in prior 3 years indicator variable, because these

variables vary only across downsizings rather than

across the full sample of firm-years. Finally, and

as already mentioned, we also control for the level

of absorbed slack and market value change.

All control variables except for the lagged

dependent variable were centered to simplify inter-pretation of the interaction terms of interest. Tem-

poral effects were controlled for through dummy

variables that divided the study into four periods

based on recessionary and expansionary periods

(not shown here to simplify presentation; all anal-

yses are available from first author).

ANALYSIS AND RESULTS

Pooled-time series analysis

As mentioned above, pooled time-series analy-sis has the considerable advantage that the effect

of independent variables on post-downsizing per-

formance can be estimated net of the effects

those variables might have on performance in

general. However, pooling multiple observations

for each firm violates the assumption of inde-

pendence underlying ordinary least squares (OLS)

regression, and may lead to biased estimates that

overstate variance across firms. To compensate,

fixed effects models were used. Fixed-effect mod-

els assume the effects of the independent vari-

ables act identically across firms and thus modelonly within-firm variation; across-firm variation

is captured by dummy variables introduced for

each firm. By construction, fixed-effect models

do not allow for time-invariant control variables

across groups of firms, such as industry dummy

variables. Accordingly, we controlled for indus-

try when constructing our independent and control

variables (such as with relative absorbed slack).

The estimation procedure also had to correct for

first-order autocorrelation of errors in the presence

of a lagged dependent variable. In such a model,

the disturbance term is confounded with effects



11/22

Reducing Slack 1097

of the lagged dependent variable. To compensate,

models are estimated using two-stage instrumen-

tal variable (within) estimation, through Statasxtivreg procedure (see Baltagi, 1995; Stata Cor-

poration, 2001).

Another issue arises because the terms of inter-

est are interaction terms of the independent vari-

ables with the Downsizing in prior 3 years indi-

cator variable. Models with interaction terms must

include a base term for each component of the

interaction (Jaccard et al., 1990). The base terms

for absorbed slack and timing require unusual lag

structures to meet this requirement, because we

assess performance in each of the 3 years follow-

ing the downsizing announcement but constructthe interaction term using the level of absorbed

slack or the market value change (i.e., timing) in

the year prior to the downsizing announcement. To

see this, consider a downsizing announced in 1984.

The interaction term for absolute absorbed slack,

for example, would be constructed using the level

of absolute absorbed slack in the pre-downsizing

year of 1983. The interaction term (which is Abso-

lute absorbed slack * Downsizing in prior 3 years )

would actually take this (1983) value, however, in

the 3 post-downsizing firm-years: 1985, 1986, and

1987 (i.e., when the downsizing indicator variable

is set to one). In 1985, then, the base term for

level of absolute absorbed slack must still be at

the 1983 level, which is 2 years back (y 2); in

1986 it is 3 years back (y 3), and in 1987 it is

4 years back (y 4). We ensure that the appro-

priate base terms are always present by including

lagged terms extending 4 years back (i.e., from

y 1 to y 4), for absorbed slack and for timing

(i.e., market value change).

The specification used here has the advantage

of allowing estimation using standard statistical

package capabilities. The models are substantively

similar (though not identical) to alternative spec-ifications in which the dependent variable is the

average firm performance in the 3 years following

a downsizing. While the alternative specification

would simplify the lag structure, the multi-year

dependent variable would produce an autoregres-

sive AR(4) model, and correction for autocorrela-

tion would be very difficult (see Baltagi, 1995).

Results

Table 1 presents descriptive statistics. Table 2 pre-

sents the results, organized in pairs of models.

In each pair, the models are identical except that

the first (A) model uses the return on market-

valued assets dependent variable (ROA-Market),and the second (B) model uses the return on book

value of assets (ROA-Book). Table 2 also includes

labels denoting which interaction term tests each

hypothesis.

Models 1A and 1B in Table 2 are control-only

models. While no hypotheses are tested in these

models, the coefficient for the Downsizing in prior

3 years indicator variable can be interpreted as

the main effect of downsizing. This is because

the coefficient represents the expected performance

difference between post-downsizing firm years and

other firm-years, when the (centered) control vari-ables are at their mean values (discussions of other

performance effects below are also in such com-

parative, ceteris paribus terms). The coefficient

is not significant in either model, and indeed its

sign differs in each. Thus there is no evidence

for a main effect of downsizing on performance

in post-downsizing firm-years, in this sample. As

was discussed earlier, prior studies of long-term

post-downsizing performance have reported mixed

results, so this finding is not particularly surprising.

Models 2A and 2B test and find support for

Hypothesis 1that post-downsizing performance

at high-absorbed-slack firms will be more positive

than at low-absorbed-slack firms, ceteris paribus.

This is seen in the coefficient for the H1: Abso-

lute absorbed slack * Downsizing in prior 3 years

interaction term, which is positive and signifi-

cant in both models (p < 0.01 for ROA-Market

and p < 0.03 for ROA-Book, respectively). A one-

standard deviation increase in absolute absorbed

slack improves a firms predicted performance

(in each of the 3 post-downsizing firm-years) by

2.7 percent for ROA-Market (0.041 * 0.67) and by

0.7% for ROA-Book (0.011 * 0.67). These effects

can be compared to the datasets overall mean val-ues for ROA-Market and ROA-Book, which are

23.2 percent and 15.6 percent, respectively (before

industry adjustments).

Models 3A and 3B also test Hypothesis 1, but

for the relative absorbed slack measure rather

than the absolute absorbed slack measure. The

coefficients for the H1: Relative absorbed slack

* Downsizing in prior 3 years interaction term

are positive, as expected, but they are not signif-

icant. Thus absorbed slack appears to influence

post-downsizing performance, but only for the

absolute absorbed slack measure. One explanation



12/22


Table1.

Meansa,standarddeviationa

ndcorrelations(n=

1367firm-years)

#

Variable

Mean

S.D.

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

1

Returnonassets

(market-valued)

0.02

0.16

2

Returnonassets(bookvalue)

0.00

0.07

0.28

3

Downsizinginprior3years

0.18

0.390.070.10

4

Absoluteabsorbedslack*


0.00

0.26

0.04

0.040.02

5

Relativeabsorbedslack*


0.00

0.170.01

0.020.01

0.62

6

Broadscope*Downsizingin

prior3years

0.0

5

0.22

0.00

0.00

0.50

0.26

0.0

5

7

Timing*Downsizinginprior

3years

0.00

0.17

0.03

0.08

0.000.01

0.060

.03

8


Broadscope*Downsizingin

prior3years

0.01

0.16

0.02

0.03

0.20

0.62

0.320

.39

0.06

9


Timing*Downsizingprior

3years

0.00

0.070.0

50.020.01

0.000.020

.100.24

0.11

10

%

Sizeofreduction*

Downsizingprior3years

0.00

0.20

0.02

0.030.03

0.03

0.040

.080.02

0.000.22

11

AssetChange*Downsizingin

prior3years

0.00

0.06

0.07

0.08

0.000.010.110

.12

0.19

0.100.08

0.06

12

Priorlay-offs*Downsizingin

prior3years

0.00

1.0

50.030.07

0.590.220.170

.240.030.0

5

0.04

0.040.07

13

Productionemployees*

Downsizingprior3years

0.00

0.180.060.06

0.400.100.010

.01

0.080.030.0

50.19

0.11

0.46

14

Returnonassets

(market-valued)(y

1)

0.02

0.1

5

0.64

0.110.08

0.030.020

.01

0.04

0.020.07

0.01

0.120.05

0.07

15

Returnonassets(bookvalue)

(y

1)

0.00

0.07

0.14

0.710.11

0.04

0.030

.00

0.08

0.030.03

0.02

0.1

50.09

0.08

0.30

16

Absoluteabsorbedslack

(y

1)

0.34

0.670.09

0.100.21

0.37

0.220

.000.02

0.20

0.01

0.03

0.020.22

0.130.09

0.09

17

Relativeabsorbedslack(y

1)

0.17

0.4

50.10

0.160.18

0.22

0.330

.06

0.00

0.080.01

0.030.020.18

0.080.11

0.1

5

0.67

18

Marketvaluechange(y

1)

0.08

0.290.08

0.100.0

5

0.03

0.000

.000.020.02

0.01

0.020.01

0.02

0.04

0.13

0.12

0.0

5

0.0

5

19

Marketvaluechange(y

1)*

Absoluteabsorbedslack

(y

1)

0.04

0.210.020.040.07

0.02

0.000

.040.01

0.00

0.010.02

0.010.08

0.02

0.00

0.04

0.27

0.16

0.21

20

Industrysaleschange(y)

0.0

5

0.140.070.210.0

5

0.070.010

.01

0.01

0.01

0.000.030.04

0.00

0.02

0.04

0.02

0.090.01

0.19

0.05

21

Assetchange(y)

0.0

5

0.1

5

0.16

0.360.1

50.01

0.000

.12

0.070.04

0.01

0.02

0.120.09

0.08

0.03

0.1

5

0.04

0.06

0.12

0.03

0.02

aBecausemostofthevariablesarecenteredandmanyareinteractions,themeansreportedabove(whileaccurate)arenotindicativeoftheactualmeansacrossthe120downsizing

announcementsinthesample.Someofthekeymeansacrossthose120downsizingannouncementsare:%

ofbroadly-scopeddowns

izings=28%;meansizeofannouncedreduction=

8.3%;%

ofdownsizingswhereproductionemployeesonlyaffected=15%.



13/22

Reducing Slack 1099

for the weaker results from the relative absorbed

slack measure is that a firms ability to identify

productively recoverable absorbed slack may bemore associated with its overall level of absorbed

slack than with whether it has somewhat more or

less absorbed slack than similar firms. Given the

stronger results from absolute absorbed slack, we

use that measure in the remainder of the analysis.

Models 4A and 4B add the remaining indepen-

dent variablesscope and timingto Models 2A

and 2B. Hypothesis 2 predicts that broadly scoped

downsizings will be associated with higher post-

downsizing performance than narrowly scoped

downsizings. This hypothesis is supported, as the

coefficient for the H2: Broad scope * Downsiz-ing in prior 3 years interaction term is significant

in both models (p < 0.09 for ROA-Market; p

the performance consequences of downsizing by large industrial firms

Documents