Biased to Downsize? A Socio-Cognitive Perspective on Workforce Downsizing

Abstract

From a rational, economic perspective, the prevalence of workforce downsizing as a managerial practice is puzzling. Studies on the performance implications of workforce downsizing have fairly consistently shown that downsizing is associated with negative reputational effects and, very often, also negative financial outcomes. To explain this puzzle why executive managers continue to downsize despite high risks of reputational and financial losses, we build on a socio-cognitive perspective on downsizing. The socio-cognitive perspective on downsizing purports that the institutionalization of downsizing goes back to the emergence and collectivization of a dominant “downsizing is effective” schema among executive managers. In keeping with this notion, we argue that the inclination of CEOs to adopt a “downsizing is effective” schema, and thus to resort to downsizing, becomes greater if CEOs have recently engaged in downsizing activity (“familiarity bias”), and if CEOs’ monetary incentives in form of stock option pay limit their financial downside when carrying out downsizing. Moreover, we reason that positive stock-market feedback to prior downsizings strengthens these links. Our empirical findings which are grounded in the analysis of 262 U.S. firms over a 12 year period are largely supportive of our theoretical reasoning. Collectively, our findings contribute to both workforce downsizing literature and behavioral (governance) theory.