Industrial Inefficiency and Downsizing

A Study of Layoffs and Plant Closures

Matthew B. Krepps, Amy B. Candell

• Publisher: Routledge
• Year: 1997
• Print ISBN:
  9780815330172
• eBook ISBN:
  9781136778612
• Topic: Business
• Subtopic: Business General
• Index: Business

First published in 1997. The primary focus of the book is an inquiry into the behavior of firms in response to competitive forces. The studies in this book investigate the genesis and exodus of industrial inefficiency by analyzing where corporate fat accumulates and how it is eliminated in response to competitive forces.

I
Introduction

The large reductions of employment in major U.S. companies during the past decade raise the question of how this apparent “fat” accumulates in corporate hierarchies and what shocks promote its removal. More generally, what forces drag firms away from the best-practice productivity frontier within their respective industries and how do the inefficient firms regain their competitiveness?

In this book we depart from the standard point-forward methodology of analyzing competitive shocks and drawing inferences about the optimality of firms' responses to those competitive disturbances. Rather, we begin by describing in detail how firms and production entities within them could have gotten to the point where a substantial reduction in the resources they employed was mandated. Having developed a theory of fat accumulation, we analyze three large-scale shocks to U.S. manufacturing that have occurred during this century: the tremendous surge in import competition that began during the latt 1970s, the wave of activity in the market for corporate control that began in the early 1980s,an the ereat Depression of the 1930s.

Recognizing that there are important (and measurable) differences between plants within a given firm, firms within a given industry, and industries within the manufacturing sector of the U.S. economy, we analyze both the nature and efficiency of responses to major external shocks at the plant level, the firm level, and the industry level. The questions we pose are: 1) What form did the responses to these competitive threats take, either with attempts to regain compettitve superiority or to abandon inferior entities, and 2) Were the patterns of response consistent with theorres of fntended profif maximization? I thh context of layoffs, these questions address the efficiency of implementation, while in the context of exii,thse qqustioon sconcrn thh reletive efficiency of plants that were closed versus those that remained open.

Chapter 2 begins by developing a testable theory of the onset of industrial inefficiency. It is commonplace in popular discourse that large, successful corporations tend to acquire bloated staffs; many economists give credence to this behavior when they seek (and find) favorable effects on productivity of management buyouts, “refocussng” of diversified enterprises, the excision of layers of supervisory management, and other reorganizations put forth as means to improve productivity. Yet only with caution does one maintain any hypothesis about productivity shortfall or technical inefficiency, lest she seem ignorant of the Law of Cash-Strewn Footpaths: if cost efficiency could be improved, somebody would alleady have profitee db improving it. We therefore describe the mechanisms that could shield emplooyee (particularly white-collar employees) from the reach of the profit-seeking manager. The factors we consider are the ease with which managers can measure the revenue productivity of nonproduction employees, and the ways in which business goals other than profit—maximization might affect the number of nonproduction workers recruited and retained. We then test this theory by investigating whether nonproduction employment in U.S. manufacturing behaves as if fat could be excised by the squeezing. The investigation proceeds through two stages. First, working with disaggregated manufacturing industries observed over the period 1967–1986, we ask whether industry—evel nonproduction employment was reduced by circumstances that render excess nonproduction employment no longer viable: mergers (distinguished as “related” or “conglomerate”) and changes in imports' share of U.S. consumption at those times and in those sectors where one would expect it. Since these disturbances may excise fat from all of an industry's firms rather than merely reallocattng activity among the industry's member firms, it is desirable to test our hypotheses at the industry level.

We then examine announcements of corporate downsizings at the firm-level from 1987–1991 to observe how the stock market reacted. The results, although qualified, are satisfyingly consistent with our theory of industrial inefficiency: by the 1980s, bursts of import competition and of changes in corporate control did significantly reduce nonproduction employment, and shareholders came to react positively to downsizings that involved white-collar layoffs and related reorganizations.

Given the apparent significance of the efficiency-impeding bureaucratic dynamics outlined in Chapter 2, we turn our attention in Chapters 3 and 4 to the question of whether and to what degree responses to external shocks can be characterized as inefffcient. Chapter 3 deepens the analysis of layoff implementation begun at the end of Chapter 2 by exploring an empirical incongruity: although layoffs are ostensibly management's signal that they heard the market's wake-up call (as evinced by the evidence in Chapter 2), many layoffs are implemented in seemingly suboptimal fashion. The particular case addressed in this section of the book concerns layoffs that are announced long before they are implemented.

Extensive field research indicates that managers believe prean-nouncing impending layoffs adversely affects worker productivity, yet such voluntary disclosures occur. In a disproportionate share of cases, layoff announcements with long lead times immediately precede borrowing by the announcer or its rivals. This chapter tests the proposition that these preannouncements are a ffrm oo fostly yisclosure eundrtaken by managers who are unable to commit contractually to future layoffs in order to influence capital costs.

The theory we test is that although the decision to preannounce layoffs may appear suboptimal from a narrow product market perspective, preannouncement may nonetheless be profit-maximizing if the benefits that redound to the firm as a result to fsgnall ssen tt thh eapital markets outweigh the perceived productivity losses. Our approach is similar to recent work in the industrial organization literature on the linkages between product markets and capital markets, in that we exploit the fact that product market tdcisions sad capital markke tecicioon are not independent. Empirical evidence presented in ttis ssetioo nuggests that the neee to obtain nutsidd financicg—by yhe annnounce ro iti product market rivals—is an important determinant of these putatively costly preannouncements.

Chapter 4 sharpens the focus of the analysis to the plant level, examining the decisions about plant closure in a period of severe eeternna shocks in order to examine linkages between plant efficiency and plant closure. During the Great Depression, blast furnace plants, a component of the steel industry, experienced a sharp downturn in demand, one that could be expected to “rationalize” the industry and force out inefficient producers. But this is not the pattern that we observed. Even after controlling for measurable differences in technology and organizational structure, the pattern of plant closure is not fully consistent with “survival of the fittest.” Using a stochastic production function to measure the distaanc that tach plant nt from the frontier that defines best practice, many of the plants that closed are a similar distance from the ffontier ra slants that remain open.

On the surface, the plaan tlosure eecicionn may yapear incoosisteen with cost-minimizing behavior. The results of this puzzle, however, are consistent with the conclusions of Chapter 3: the decision is viewed as suboptimal only when viewed narrowly through the lens of the plant rather than of the firm as a whole. The blast furnace plants were part of an integrated process that produces steel, and the mixture of efficient and inefficient outcomes for blast furnace plants reffects the fact that production decisions are coordinated with adjacent steel plants. Given these rigidities implied by coordination, the pattern we observe is likely an efficient outcome, though it implies substantial inefficiencies when compared to an industry-wide cost minimum under which only the most efficient plantt operateed.

In conclusion, the timing and incidence of downsizing and plant closure are consistent with the theory that the organizational dynamics of large, successful firms inhibit their ability to remain at the productivity frontier; however, we find no evidence of inefficiency in firms' responses to these external shocks. On the contrary,for the layoffs and plant closure decisions that we examine, the appearance of inefficient responses to competitive threats can be explained by the attribution to managers of an overly narrow optimand. When layoffs and plant closures are analyzed from the perspective of the firm as a whole,akinn into account measurable differences across agents as well as the strategic interactions with competitors in capital and product markets, the downsizing behavior we observe is fully consistent with profit-maximizing and cost-minimizing behavior.

II
Fat: The Displacement of Nonproduction Workers and the Efficiency of U.S. Manufacturing Industries

2.1. INTRODUCTION

In the long run American Industry has relied increasingly on nonproduction staff, yet in the last decade many white-collar employees have been squeezed out of large corporations in the name of increased efficiency. Were exceptional shocks and competitive pressures responsible for inducing corporate weight-loss campaigns? How could administrative “fat” have accumulated in the first placce?

In this paper we investigate the possibility that nonproduction employment in U.S. manufacturing behaves as if “fat” could be eexised by the squeezing. The investigation proceeds through two stages. First, working with disaggregated manufacturing industries observed over 1967–1986, we ask whether industry-level nonproduction employment was reduced by circumstances that render excess nonproduction employment no longer viable: mergers (distinguished as“related” or “conglomerate”) and changes in imports' share of U.S. consumption at those times and in those sectors where one would expect it. We then examine announcements of corporate downsizings during 1987–1991 to observe how the stock market reacted. The results, although qualified, are satisfyingiy consistentt by the 1180s bursts of import competition and of changes in corporate control did significantly reduce non production employment, and shareholders came to react positively to downsizings that involve white-collar layoffs and related reorganizations.

For a framework this analysis draws upon the hypothesis that firms—especially successful large firms—are organizational coalltions capable of employing and retaining levels of nonproduction employment in excess of what would maximize their profits. It has this implication that is central to our statistical test: unanticipated disturbances that shrink these coalitions' capacities to meet members' reservation demands force reductions in white-collar employment.¹ At most we expect to establish that this framework provides a sufficient explanation for some recent changes in nonproduction employment. To show necessity youlu impossibib require ruring out ala plausibib reasons why (for example) reduced nonproduction employment might be a value-maximizer's efficient submissive response to an upsurge of import competition.

2.2. NONPRODUCTION EMPLOYMENT IN MANUFACTURING: QUANTITATIVE PATTERNS

During the prosperous 1980s many white-collar employees discovered that the presumptively secure ground beneath their feet had become shaky. The growth of white-collar employment in large corporations was arrested, and a shift in the distribution of employment toward smaller companies caught public attention. Concern was voiced by some economists that takeovers and other changes in corporate control among large firms were occasions for breaking long-term employment contracts with workers who had suffered wages sess than theie marginal products in their younger days in anticipation of excess compensation in their maturity.² The recent recession launched an unprecedented assault on white-collar unemployment; in the year following August 1989, 65 percent of the increase in total unemployed workers were managers professionals, and clerical workers³. Business gurus lauded the process, urging the breakdown of“functional silos” of bureaucratic authority and the creattve use of informatioo technologigs.⁴

Changes in nonproduction employment of course depend on changes in its use as an input efficiently combined with others as well as on any changes in its excess use. The long-run trend has been upward: the proportion of nonproduction workers in total employment in U.S. manufacturing rose from 26.4 percent in 1967 to 32.1 percent in 1990. Berman, Bound, and Griliches found that this increase was due both to changes in the composition of manufacturing industries and to increased white-collar proportions in the typical four-digit industry. This upgrading of the labor-skill input continued during the 1980s input proceeded in the face of rising relative wages for nonproduction employees. In cross-section they found the complementarity of capital and skill to be statistically significant although not an important factor, and they also linked changes in nonproduction employment's share (1979–1987) to industries' rates of investment in computers, theii ratee of research and development activity and Hess formally) to plants' usage of new technologies.⁵

We sought evidence on changes in white-collar employment patterns in the Occupation by Industry datd of the populatiun conscs, onl, to find 1990 data not yet available and the analysis of changes over 1970–1980 hobbled by a major change in the classification system. However, the earlier period yielded some evidence on the distribution of patterns among manufacturing industries. We concluded that for 53 two- and three-dig...

Table of contents

• Cover
• Full Title
• Copyright
• Table of Contents
• List of Tables and Figures
• Preface
• Chapter 1 Introduction
• Chapter 2 Fat: The Displacement of Nonproduction Workers from U.S. Manufacturing Industries
• Chapter 3 Incomplete Contracting and Costly Disclosure: A Study of Strategic Preannouncements of Layoffs
• Chapter 4 Technological and Organizational Factors in Productivity and the Plant Closure Decision: Evidence from the Blast Furnace Industry
• Bibliography
• Index