The Upside to Downsizing: Mispricing Layoffs and Firm Value

Abstract

Contrary to popular opinion, one-third of mass layoffs announced by S&P 500 firms do not result in downsizing, yet the market fails to identify this anomaly in the short-run. Therefore, I construct a real-time layoff index to predict the probability of downsizing following an announcement and show that an investment strategy, long in the bottom half of the index (Downsizing), generates an annual four-factor alpha of 6.96%. Downsizers create value in the long-run because they successfully reduce costs, increase liquidity, and improve performance. Importantly, Downsizers also ensure that managers commit to downsizing by raising additional debt prior to the announcement.

Keywords: Mispricing, Layoffs, Firm Performance, Human Capital Disclosure, Involuntary Turnover

JEL Classification: G14, J63, G32, L25