The effect of downsizing on the financial performance and employee productivity of Korean firms

Purpose – The paper's objective is to explore the effect of downsizing on both a firm's financial performance in terms of profitability and efficiency, and a firm's employee productivity. Design/methodology/approach – Analyzed six‐year longitudinal financial data of 258 listed Korean firms between 1997 and 2002 along with survey data of 2000. Using multiple regression, the paper investigated the relationship between downsizing and three measures of financial performance and two measures of organizational performance: return on assets, asset turnover, operating income per employee, sales per employee, and value added per employee. Five dependent variables were standardized by industry average. Findings – First, firms implementing downsizing tended to suffer more financial difficulties than their counterparts. Second, downsizing showed a positive effect by improving a firm's profitability and efficiency, but no effect on employee productivity. Third, the improvement of financial performance (ROA) by downsizing was greater among companies that had not experienced any loss than among those that had experienced loss. Research limitations/implications – First, there is a possibility of overestimation or underestimation since we do not know if firms classified as non‐downsizers actually downsized during 2000‐2002. Second, the magnitude of downsizing was not measured. Third, the effect of layoff and “honorable retirement” was not analyzed separately. Practical implications – Downsizing is more effective when a firm implements it proactively, and less effective when a firm implements downsizing after a financial loss as a “quick fix” to a financial problem. Originality/value – The paper utilizes a unique experiment opportunity with Korean firms since the economic crisis in 1997 to investigate the recent phenomenon of downsizing in Asian countries. The paper provides new evidence for why downsizing can improve a firm's financial performance, but not employee productivity in Korean firms.