Stock Market Psychology: How Stock Markets React to Mass Layoffs

According to previous research, mass layoffs, or downsizing, usually have a negative effect but sometimes also a positive effect on a company's share performance. Decisive factors are the popularity and frequency of such measures, as Schulz and Himme show in their paper in a recent issue of the prestigious Socio-Economic Review. This becomes clear when looking at the years 1990 to 2010 – when there were significantly more frequent mass layoffs than before. As a result, stock prices initially went down. Gradually, however, the common practice of downsizing became legitimate for investors, and stock market returns were more positive on average.

The authors conclude that companies strongly base their decisions on the expectations of financial backers (shareholders). "This psychological approach is new," Dr. Alexander Himme, Professor of Management Accounting, explained. "We looked at two decades of data for this and saw in this historical view that investors' expectations are crucial." Companies wanted to make their investors happy. So when investors deemed "lean" companies efficient and powerful, management followed the trend of mass layoffs. This behavior mirrors the emphasis on shareholder value from the 1990s onward. In this context, corporate success is no longer measured in terms of profit, but in terms of shareholder wealth. Mass layoffs were given a positive spin as "healthy cutbacks."

This approach can also be applied to more recent trends influencing management. “Today, companies feel increased pressure from investors to position themselves on sustainability, corporate social responsibility, and digitalization,” Prof. Himme said.

More information:

Ann-Christine Schulz, Alexander Himme, “Stock market reactions to downsizing announcements: an analysis through an institutional lens,” Socio-Economic Review, 2021; mwab046, https://doi.org/10.1093/ser/mwab046