Corporate Downsizing Essay, Research Paper

Introduction

The U.S. economy was at the height of economic expansion, stocks were near all time highs, corporate profits were strong, and the unemployment rate was at its lowest in two decades. At the same time, the major corporations in the United States were firing workers by the hundreds of thousands, and job insecurity had risen to an extremely high level. What was also ironic was the fact that the corporations who were initiating the downsizings were considered to be some of the strongest and most profitable in the country. Although these events seem to be inconsistent, this is what has happened throughout the decade of the 1990’s.

Traditionally, downsizing was a direct result of a decline in the demand for a firm’s product. This would mean that fewer items needed to be produced, therefore less employees were needed. Downsizing was also used as a way to cut costs during times of recession. But, the downsizings observed in the 1990’s did not fit this mold. Instead of downsizing for survival, companies were using this as a strategic plan for creating an increase in stock prices.

The intent of downsizings by these top corporations who were already very profitable was to become “lean and mean”. However, results of a survey published in the Wall Street Journal suggested that many of the firms did not meet their goals.

While corporate downsizing gets the publicity, the American economy has steadily grown richer. Many times the public confuses downsizing with recession, but in reality affects a single industry that is trying to accommodate itself to new realities of the market. While some industries have downsized, the economy has continued to grow.

History of Downsizing

Downsizing is defined as a reduction in the number of employees, and sometimes in the number of operating units within a company. It began as a strategy of weak corporations as a way to reduce the costs of the company. Shareholder wealth was the main concern, and companies were willing to do whatever they thought necessary to convince the market that the stock price should rise. The stock price had become more important in the decisions of top management because many companies were offering stock options to them as part of their salaries. Downsizing was being used as a survival strategy by corporations who were trying to increase their market values. It was often perceived as making a company more competitive in today’s global marketplace.

In typical downsizing, a profitable firm would announce to the public that it was firing a large percentage of its workforce. The idea was that the market would get excited and begin buying up the firm’s stock at a higher price. But, there are different views on how stockholders react to this kind of news.

The idea that downsizing increases stock prices is fueled by the belief that if earnings are to be maintained and improved, corporations have one alternative-cut costs. This usually meant cutting jobs because trimming the payroll seemed to be an easier way to increase profits in the short run. Downsizings also had everything that a company wanted when trying to increase stock prices-they were tragic and newsworthy and they showed that a company was serious about its cash flow.

Downsizing not only reduces the number of employees, but often shrinks the number of management levels as well, and middle managers have been particularly vulnerable to downsizing changes. Downsizing is usually done by a company because of the perceived effect of more efficiency, resulting in cost reductions.

This trend has emerged due to the idea that corporate downsizing will increase the stock price of a company. This paper will focus on this issue by looking at two major companies who have downsized in the last few years and the effects, if any, that it had on their stock prices.

Assumption of the Analysis

Before progressing further, it is important to qualify the companies in this data set as relevant for the purpose of carrying out this study. Specific qualifications are necessary to ensure that the information utilized from the companies selected is an accurate representation of downsizing. Therefore, a company should be included in the data set if it meets the following criteria:

?The company is public and is listed on the NASDAQ or the New York Exchange at the time of downsizing.

?The company’s principal offices are located in the U.S.

?The company was not bankrupt or in the process of reorganizing at the time of downsizing.

?The downsizing was publicized in a reputable news-related periodical or a newspaper such as the New York Times.

Not only are there specific requirements for the selection of companies, but labor decisions categorized as downsizing must also be carefully indicated. Therefore, the second assumption is that downsizing is differentiated from some other form of corporate reorganization such as “layoffs” in the following manner:

?The company eradicated a minimum of $2,000 if it has more than 20,000 employees.

?The company eliminates a minimum of 20% of its workforce if its payroll personnel consists of less than 20,000.

?Positions that are eliminated involving special “incentive ” or severance packages are included.

?Eliminations that are results of mergers are also included.

Statement of the Problem

Given the aforementioned assumptions, the statement of the problem is that downsizing irequires that a firm fire a large quantity of their workers all at once, (indicating decreasing equity value of a firm), however, the number of workers fired tends to increase the long-run return of the stock.

Objective of the Study

Therefore, the objective of this study is to use stock prices as a medium to measure the efficiency of companies. Particularly, this study focuses on mainly two corporations, Delta and United Airlines. The goal of the authors is to use the stock prices, (taken from a secondary source), of these companies as a determinant of the company’s success or decline during its period of downsizing. This paper will show that although downsizing is shown to be a rare event in the evolution of stock prices, it does actually constitute relevant and favorable news to the equity of a firm.

Hypothesis Testing

The aforementioned sections of this study have discussed the reasons of downsizing and its effects on the companies undergoing such a reorganization process and have identified stock prices as the factor to indicate the effect on the company’s financial position. Such a factor is a very effective determinant for analyzing whether downsizing had any effect on the company or to signal if the company did indeed meet its objective.

Hence, for the purposes of this study, hypotheses testing applying the stock prices of two different companies will be used. As stated, the two companies considered for our testing are Delta and United Airlines. Procedurally, the authors have used the stock prices of these two companies from the Wall Street Journal . The indicated periods used are those that range from a few months before the downsizing took place until some few months subsequent to the downsizing. The aforementioned periods include the transition period. As shown in the tables, the two separate companies are defined and following is the implementation of the Independent Sample t test. The t test is used to prove or reject our assumptions.

The entire procedure is explained and verified in seven steps, which are as follows:

a.Hypotheses:

As previously stated, the main objective of conducting this test is to prove that the downsizing does effect the stock prices of a company. It increases or decreases the stock prices depending on the type of downsizing undergone. So this hypotheses ratifies our assumption that the stock prices can either increase or decrease with the decision of downsizing. The null hypotheses and the alternative hypotheses would be as follows.

H0: mA 0

Here we are considering that zero as the base value i.e. the value that the company held prior to the company undergoing downsizing. We could not have any other number other than zero because we are comparing two different companies which had two different values before downsizing; hence we have a common platform for showing that the two companies under consideration meet our assumptions.

b.Test Statistic:

We are under the assumptions that stock prices are approximately normally distributed. The sample sizes which we considered for this testing are small. The population variance is not known. Therefore, according to the flow chart for deciding between z and t and given the above-stated, information we are conducting the test according to the t-distribution.

Hence the test statistic would be,

t = x -mo

————

(S^2) / n

Where x = the mean of the stock prices

S = the standard deviation

S^2 = the variance of the sample

n = the sample size.

c.Significance Level:

Assuming that the consequences of committing a Type I error, (rejecting HO when it is true), is such that we are willing to take a 1 in 20 or 5 in 100 chance of committing. Since our mean weight is zero, as stated in the null hypotheses, we would like to reject the null hypotheses and so decide to make the probability of rejecting the null hypotheses (if it happens to be fairly small) 0.05.

Hence, let the significance level a = 0.05

d.Decision Rule:

The fact that there is an inequality in the alternative hypotheses indicates that this is a one- sided test. All of a = 0.05, therefore, will be in one tail of the distribution of the test statistic. Since the computed values of the test statistic that are sufficiently small will cause rejection of the null hypotheses, the rejection region will be in the right tail. The critical value of t , then, is that value of t to the right of which lies 0.05 of the area under the normal standard curve.

The table showing the values for t distribution gives us the critical value of 1.7613 when we interpolate. Therefore, we may state the decision rule as follows: if the value of t computed from the sample data which we are using is greater than the critical value of t 0.95, 14 which is 1.7613, we reject H0 ; otherwise we do not reject HO.

e.Calculations:

Lets first consider testing in the case of Delta Airlines. The calculations and the result for this case obtained by using the SPSS program are attached with this paper. A random sample of the size of 15 yielded a mean of 115.6667. The results also show the value of t as 26.692 with degree of freedom of 14 and a significance level of 0.00.

The second case is that of United Airlines. The calculations and the results for the same obtained by using the One-sample t-test using the SPSS program are attached . A random sample of 15 yielded a mean of 165.6667. The results also show the value of t as 6.145 with a degree of freedom of 14 and significance level of 0.000.

f.Statistical Decision:

Upon generating the decision rule, we have determined that we would reject HO if the computed value of t is greater than the critical value of t. Hence, from the calculations, we are obtaining a computed value greater than the critical value in both cases. For example,

In the case of Delta Airlines:

t(COMPUTED ) > t(0.95.14)

26.692 > 1.7613

In the case of United Airlines:

t(COMPUTED) > t(0.95,14)

6.145 > 1.7613

We are rejecting Ho. Also, we can conclude that the significance level obtained from calculations is less than the significance level we have assumed, which is that of 0.05. This means that the t value computed is not as significant as we want and therefore, leads to the conclusion that we can reject Ho.

g.Conclusion:

In conclusion, the decade of the 1990’s has proven to be one of inconsistent events regarding various company’s efforts to downsize. Given a standard statistical and/or micro-economic scenario, a weak firm anticipates a slump in the demand for its products, and lays off workers, while a strong firm foresees a jump in the demand for its products, and hires more workers. However, as in this case regarding Delta and United Airlines, the need for companies to downsize has taken on somewhat of a different purpose. The aim of this study was to prove our assumption that the factor of downsizing has some effect on the stock prices of a company, which we considerd as a medium to measure the efficiency of a company in terms of the company’s financial position when downsizing occurs. The authors were able to conclude that downsizing does change the stock prices to some extent in certain cases and in other cases to a large extent. Even though this test involved only two companies- Delta and United Airlines- we have sufficient evidence to affirmatively draw the conclusion that, yes, when used as a medium to determine a company’s efficiency, the company’s decision to downsize does have a positive effect on its stock prices.

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