Microsoft's (NASDAQ:MSFT) recent announcement that it will cut 18,000 jobs was much higher than anyone expected. It's the company's largest layoff by headcount since it laid off 5,800 employees in the midst of America's Great Recession back in 2009.
Microsoft isn't the only one to make such striking job cuts. Global pharmaceutical company Merck (NYSE:MRK)is in the middle of a two-year plan to reduce its workforce by about 20% -- which equates to about 16,000 employees. At the end of it all, the company expects this to contribute substantially to its goal of saving $2.5 billion by 2015.
Eliminating jobs is obviously bad for those on the receiving end of the downsizing. But it's also possible for massive layoffs to hurt the companies as well. Conventional wisdom says massive layoffs create a more efficient company and makes it easier for the company to retain profits. But the research on mass layoffs may paint a different picture on the long-term benefits of deep employee cuts.
The cost of layoffs
Researcher Wayne F. Cascio from the University of Colorado's business school found that simply cutting jobs isn't the answer. Companies need to change how the business is run as well. Cascio looked at data up to nine years after a company's downsizing event and found that, "As a group, the downsizers never outperform the non-downsizers. Companies that simply reduce headcounts, without making other changes, rarely achieve the long-term success they desire."
He notes that massive cuts lead to fewer sales people, less research and development, and a loss of high-producing individuals. The result is lower sales, reduced product innovation, and decreased productivity due to low morale.
Cascio's research also points to increased costs for companies when they reduce the workforce. He mentioned IBM had to spend $700 million in 2008, just for employment restructuring. In Microsoft's case, the company is cutting both professional and factory jobs, many of which will be aimed at current Nokia workers, which were absorbed into Microsoft when it purchased Nokia's mobile division. The company says it will spend between $1.1 billion-1.6 billion to reduce its workforce.
Aside from losing talent and increasing some costs, there are implications for a company's stock price as well.
Is this really good for the stock?
Sometimes investors respond positively to layoff news. The few days after Microsoft announced its job cuts, its stock price was up more than 5%. Researchers from Cornell University have found that since the 1970s investor reactions to layoffs have become "less negative".
But even if a stock price has no change -- or even a positive one -- following a substantial layoff announcement, research from the Human Resources Management Association shows the lift in stock price may only be temporary.
In a research briefing released in 2012, the association said:
The stock market may respond positively to companies that announce extensive restructuring, and may briefly lift the company's share price. But in the long term, the majority of companies that have instituted forced layoffs did not realize improved financial performance either on the balance sheet or on the stock exchange.
A 2010 Newsweek article seems to confirm this. Based on 141 layoff announcements between 1979 and 1997, mass-layoffs lead to negative stock returns "with larger and more permanent layoffs leading to greater negative effects." That same article mentioned another study of 373 companies that showed both U.S. and Japanese companies saw "negative abnormal shareholder returns" after layoff announcements.
Obviously, all of this doesn't mean Microsoft made the wrong decision, or that companies in general can't benefit from reorganization.
Sine July 2011, Cisco Systems (NASDAQ:CSCO) has announced about 12,000 job layoffs. The first big round of cuts reduced the company's workforce by about 16%.
But from July 2011 to July 2014, Cisco's stock is up more than 60%. Clearly, the research doesn't apply to every company in every situation and there is, of course, much more that determines a company's stock price than its layoff practices.
But what the research does show us is that layoffs -- aside from the obvious downside for current employees -- aren't always necessarily a good thing for companies or their investors. As Microsoft's job cuts were just announced, it's too early to tell what impact it will have. But taking into account even some of the data, investors should be at least a little bit leery it'll payoff in the end.
Chris Neiger has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of International Business Machines and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.