THE HIDDEN COSTS OF DOWNSIZING: Experimental evidence of the potential damage to the performance of surviving staff

Firms that lay off staff can see a significant reduction in the performance of their remaining workers, according to an experimental study by Frank Drzensky and Matthias Heinz. Their research, published in the December 2016 issue of the Economic Journal, suggests that firms that decide to ''downsize'' their workforce should be very wary of how the decision is perceived. If the surviving staff interpret the decision as a way to boost profits, they will react particularly negatively.

The researchers set up an experiment to assess how non-fired employees (the ''survivors'') react to an employer''s decision to fire a co-worker. Employees work for an employer whose payoff depends on the employees'' performance. Subsequently, the employer is provided with an incentive to fire an employee. After this decision, the remaining employees continue to work for the employer.

To investigate whether the behaviour of the survivors is driven by the employer''s layoff decision or its implementation, the researchers conduct a control treatment in which it is randomly decided whether an employee is fired or not.

The results show that survivors reduce their performance substantially in response to the employer''s decision to lay off a co-worker. The reduction is strongest for survivors who interpret the employer''s decision as a method to increase profits at the cost of the workers; it is weaker if they can comprehend the layoff decision, and it vanishes if the employer is forced to fire a worker.

These results imply that firms deciding in favour of layoffs should be wary about how the decision is perceived by their workers. Firms may use several methods to indicate that the goal of layoffs is not to increase profits at the expense of the workforce, and thus limit the negative responses of survivors.

For example, firms could use natural fluctuations to reduce the level of staffing, claim that layoffs are the ''last resort'' or cooperate strongly with works councils at times of downsizing. Firms could also hire an interim manager during restructuring, offer outplacement services or make financial offers for voluntary leavers.

The researchers note that layoffs are an integral part of modern economies. The US Bureau of Labor Statistics says that each year firms report on average around 6,700 mass layoffs resulting in 1.2 million dismissed workers.

As layoffs impose costs on the dismissed workers, the regional economy and social insurance, it is no surprise that layoffs receive a lot of attention by practitioners, scholars and the general public. The heated debate in the 2012 US presidential campaign around Mitt Romney''s prior involvement in mass layoffs is a case in point.

''The Hidden Costs of Downsizing'' by Frank Drzensky and Matthias Heinz is published in the December 2016 issue of the Economic Journal. Frank Drzensky is at Goethe University Frankfurt. Matthias Heinz is at the University of Cologne.