Understanding Competitive and Contagion Effects of Layoff Announcements

Abstract

When a firm announces a significant permanent layoff, the firm's reputation among key stakeholders such as employees and investors suffers. However, what does this action mean for rival firms? How does the information contained in a layoff announcement by one firm transfer to the reputations of other firms in the industry? Building on the similarity between the reputation formation process and the firm valuation process, we use stock price as an aggregate measure of firm reputation in the eyes of shareholders. We examine how changes in the announcing firm's reputation affect the reputations of rival firms, through changes in their stock prices, in the same (contagion effect) or opposite (competitive effect) direction. This paper examines a longitudinal sample of layoff announcements in the US oil and gas industry from 1989 to 1996. Results suggest that reputation effects of layoff announcements spillover beyond the announcing firm and extend to other firms in the industry. These inter-organizational reputation effects follow a contagious process, that is, if shareholders respond negatively to a layoff announcement, they will exhibit simultaneous negative reactions for non-announcing firms and that the negative effects of layoff announcements increase with layoff prevalence. Furthermore, we find that close rivals experience a dampening of the contagion effect, perhaps reflecting countervailing competitive effects. By examining layoff announcements through both the institutional reputation and resource-based lenses, our work begins to reconcile how the two competing forces of cooperation and competition work together to influence firm-level outcomes.