Disclosure strategies and investor reactions to downsizing announcements

J. Account. Public Policy 36 (2017) 239–257

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J. Account. Public Policy

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Disclosure strategies and investor reactions to downsizing announcements: A legitimacy perspective

http://dx.doi.org/10.1016/j.jaccpubpol.2017.03.003 0278-4254/� 2017 Elsevier Inc. All rights reserved.

⇑ Corresponding author at: Schulich School of Business, York University, 4700 Keele Street, Canada. E-mail addresses: emmanuelle.negre@umontpellier.fr (E. Nègre), marie-anne.verdier@univ-tlse3.fr (M.-A. Verdier), ccho@schulich.yorku.ca (C

dmpatte@ilstu.edu (D.M. Patten).

Emmanuelle Nègre a, Marie-Anne Verdier b, Charles H. Cho c,⇑, Dennis M. Patten d a University of Montpellier, France b University of Toulouse 3 Paul Sabatier, France c Schulich School of Business, York University, Canada d Illinois State University, United States

a r t i c l e i n f o

Article history: Available online 17 April 2017

Keywords: Disclosure strategies Downsizing operations Impression management Legitimacy theory Press releases

a b s t r a c t

In this paper, we focus on a relatively underexplored aspect of sustainability—workforce reductions. We investigate the determinants and consequences of the decisions made by French firms to use press releases in order to announce downsizing operations. We also examine whether the content of press releases has an impact on investor reactions to downsizing announcements. Particularly in the French context, downsizing operations reflect negatively on corporate social responsibility with respect to employees, and we anticipate that French managers will use disclosure strategies to counter a potential legit- imacy threat. Our sample consists of 227 downsizing operations announced between 2007 and 2012 by 119 French listed firms. We find that the disclosure of press releases is driven by both contextual and legitimacy factors. We also find that press releases are associated with more negative reactions to downsizing announcements than when there is no press release, particularly in the case of proactive operations (i.e., implemented by firms with improving performance). A content analysis of press releases indicates that firms, on aver- age, engage in a reactive impression management strategy in their disclosure that consists of attributing downsizing operations to external factors. Moreover, investors penalize the use of proactive arguments, particularly when they are used to justify proactive operations. Overall, our results show that, in the French case, disclosure strategies and their conse- quences on the financial markets relate to a legitimacy perspective.

� 2017 Elsevier Inc. All rights reserved.

1. Introduction

Organizational sustainability includes the economic-financial, environmental, and social aspects of organizations (e.g., Jabbour and Santos, 2008). However, to date, most research in the sustainability domain focuses on the environmental aspect of sustainability as opposed to its social dimension (Sharma and Ruud, 2003). And while recent literature on integrated reporting in sustainability accounting (e.g., Baboukardos and Rimmel, 2016; Melloni et al., forthcoming) does consider dif- ferent CSR dimensions, specific categories are not examined in-depth.

.H. Cho),


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In contrast, in this paper we explore the social issue of workforce reductions. Consistent with Wilkinson (2005), we argue that downsizing operations1 have an adverse impact on sustainability and we note that these operations have been the subject of much controversy. More specifically, several studies note that downsizing operations are perceived by society as a breach of the social contract between organizations and society (e.g., Mäkelä and Näsi, 2010; Van Buren, 2000; Vuontisjärvi, 2013). Accordingly, the issue of workforce reductions falls within the domain of corporate social responsibility (CSR)/sustainability research since the operations have adverse societal consequences, particularly for employees. From an ethical perspective, downsizing operations can also be seen as a questionable business undertaking (Vuontisjärvi, 2013) and are generally imple- mented in order to improve firm efficiency and to maximize value for shareholders. However, for employees and the local com- munity, downsizing operations usually mean significant losses that can be difficult to support (Mäkelä and Näsi, 2010).

Such a breach of the social contract can have severe economic consequences for firms—for instance because of potential strikes or boycotts (e.g., Hunter et al., 2008), which could destroy value for shareholders through lost customers and rev- enues.2 This would be especially true for ‘‘proactive” downsizing operations as they are considered less ethically justifiable (Van Buren, 2000) because they are not justified by apparent financial needs (Love and Kraatz, 2009). Downsizing operations can thus be viewed as negative social events (e.g., Barclay et al., 2005; Flanagan and O’Shaughnessy, 2005; Leana and Feldman, 1988) that create legitimacy threats for organizations. Consequently, companies facing legitimacy threats may use dis- closure strategies to alter perceptions about the legitimacy of the organization (e.g., Beelitz and Merkl-Davies, 2012; Cho, 2009; Cho and Patten, 2007). If this is the case, we would expect to find that, when companies disclose the logic behind downsizing operations, they would be more likely to make them appear more reactive (or less proactive) than they are in reality.

In addition, prior research examines the impact of downsizing announcements on the reaction of financial markets (e.g., Chalos and Chen, 2002; Elayan et al., 1998; Hillier et al., 2007; Lee, 1997) and generally shows a negative investor reaction (e.g., Chen et al., 2001; Elayan et al., 1998; Hillier et al., 2007; Lee, 1997; Lin and Rozeff, 1993; McKnight et al., 2002; Ursel and Armstrong-Stassen, 1995; Worrell et al., 1991). Evidence also suggests that the reason why (proactive or reactive) down- sizing operations occur influences financial market reactions. However, while these prior studies primarily focus on code-law countries and adopt an economic perspective to explain results, we argue that the investigation of downsizing operations in more stakeholder-oriented countries requires consideration of other perspectives such as their potential threat to corporate legitimacy.3

In this study, therefore, we examine the determinants and consequences of the decisions made by French firms to use press releases in order to announce downsizing operations, through a national lens and by adopting a legitimacy perspective. We also examine whether the content of the press releases has an impact on investor reactions to downsizing announce- ments because the analysis of disclosure strategies aligned with such announcements highlights the potentially important role of disclosure in influencing investor response to downsizing announcements. We specifically focus on the French con- text where the need to justify and legitimate downsizing operations through disclosure strategies seems particularly strong. The French legal system protects workers and makes it difficult and costly for firms to dismiss workers (Cascio, 2005), and France is historically known for its strong conflicts between managers (or shareholders) and employees. While cooperation between both parties has been improving to some extent, the country’s protest culture – documented by a high strike rate – is still prevalent and leads to high exposure of downsizing operations in the media.4 Further, and importantly from a legit- imacy perspective, Jung et al. (2015, p. 2064) argue that ‘‘the nature of employment reduction in France is distinct from ‘offen- sive’ layoffs more common in the USA in the last three decades.” They note that in the U.S. firms ‘‘increasingly rely on employee layoffs [. . .] to improve financial performance in the context of increased pressures from shareholder value-driven institutional investors,” while in France, poor performance is the key driver to employment reduction (Jung et al., 2015, p. 2062–2063). Accordingly, proactive operations in France are often viewed as an ‘‘injustice” creating political tensions and generating a need for communication. France is thus a unique setting to examine downsizing operations as these events constitute significant threats to firms. Examining 227 downsizing operations implemented between 2007 and 2012 by 119 French listed companies, we find that the disclosure of press releases to announce downsizing operations is driven by both contextual and legitimacy factors. With respect to the former, we find that press releases are more likely for firms that implement a downsizing for the first time during the period studied, and less likely when downsizing operations are implemented through layoffs rather than voluntary measures (e.g., early retirements, voluntary redundancy plans). With respect to legitimacy-related factors, we

1 We use the term ‘‘downsizing operations” and ‘‘workforce reduction” interchangeably in the paper as we consider them synonymous. As we note in the methods section below, our sample of events includes downsizing operations related to both layoffs and voluntary reduction measures (such as voluntary retirement). We control for differences in these types of reductions in the analysis.

2 An illustration is the 2001 consumer boycott on Danone, a French multinational food and beverage firm. While it was generating high profits, Danone announced a cut of 3000 jobs in Europe, including 1700 in France. This operation was seen as a ‘‘public outrage” (Hunter et al., 2008, p. 338) even by some politicians who ordered hospitals and schools to stop buying Danone products. The Danone logo was modified to include the slogan ‘‘Human beings are not yogurts”. Despite Danone denying the impact of the boycott and strikes on firm performance, a serious decline in the company’s sales and market capitalization has been reported by financial analysts and the media.

3 In the legitimacy perspective, the target audience for disclosure is wider than in the economic perspective and includes several stakeholders (e.g., customers, employees, etc.).

4 For example, on October 5th, 2015, Air France-KLM’s angry employees interrupted a meeting in which managers and employee union representatives were discussing a new large downsizing operation. This operation caused both violent protests and actions against Air France-KLM’s CEO and Human Resources Director and this incident was subject to much international media exposure. French President François Hollande denounced this violence as ‘‘unacceptable and bad for France’s image”. He added that ‘‘social dialogue is important, and when it is interrupted by violence and disputes take on an unacceptable form, it can have consequences for the image and attractiveness [of the country]”.

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find that the probability of the use of press releases increases for firms that belong to socially sensitive industries, and decreases when firms implement downsizing operations during a financial crisis period. We also report a negative association between downsizing announcements via press releases and market reaction. With respect to proactive operations, we find that despite an overall positive (but not significant) market reaction to proactive operations, the reaction is, on average, negative when firms announce such operations through press releases. Finally, content analysis of the 66 press releases issued by sample firms to announce downsizing operations shows that numerous French firms appear to adopt a reactive impression management strat- egy, in that the language of the press releases make the downsizing operations appear more reactive (or less proactive) than they are in reality. This suggests that firms consider legitimacy concerns when adopting disclosure strategies. We also find that the more firms use proactive arguments to justify downsizing operations, the more investors in the French market react neg- atively to such operations. This result contrasts with the one of prior studies conducted in common-law countries that docu- ment a positive market reaction to downsizing announcements if the reasons stated within such announcements are proactive (e.g., Abraham, 2004; Elayan et al., 1998). In addition, the use of proactive arguments in press releases disclosed to announce proactive operations is negatively related to market reaction. Therefore, investors do not penalize the use of impres- sion management. On the contrary, they react negatively to disclosures that could increase a potential legitimacy threat. Overall, our results show that in the French case, disclosure strategies and their consequences on the financial markets relate more to a legitimacy perspective.

Our research extends the empirical literature on both downsizing and sustainability in four different ways. First, most prior research defines proactive and reactive operations according to the reasons stated within downsizing announcements (e.g., Abraham, 2004; Elayan et al., 1998; Lee, 1997; Worrell et al., 1991). However, we provide evidence of impression man- agement strategies in such announcements; that is, firms appear to justify downsizing operations by using reactive argu- ments—they establish a link between the decision to downsize and external events (e.g., bad market or sector conditions) and internal financial difficulties potentially in order to offset any legitimacy threats. Second, we take into account how downsizing operations are brought to the public’s attention (i.e., by the media or directly by the firms through press releases). By issuing press releases, firms keep control of their communication and thus could manipulate a particular mes- sage and make it easier to accept. However, our results suggest that disclosures made via these releases are more likely to damage firm organizational legitimacy. This stands in contrast to Griffin and Sun’s (2013) findings of positive market reac- tions to U.S. company press releases related to carbon emissions. Third, we examine the market reaction to downsizing announcements in a code-law country such as France in which legitimacy considerations are strong and very relevant regarding labor issues (Harris et al., 1994; Mora and Sabater, 2008). In contrast, most prior research has been conducted in common-law countries and finds that when managers mention proactive arguments to justify downsizing operations, investors react positively or less negatively than when reactive arguments are given (e.g., Abraham, 2004; Elayan et al., 1998; Gunderson et al., 1997; Hahn and Reyes, 2004; McKnight et al., 2002). Our results show that, in France the market perceives badly the use of proactive arguments presumably due to concerns with potentially damaged legitimacy. Finally, despite the large number of studies on sustainability issues to date, little attention has been paid to the social dimension of CSR activities and their relation to the concept of sustainability (Kent and Zunker, 2013; Mäkelä and Näsi, 2010). By inves- tigating the disclosure strategies and market reactions to downsizing announcements from a legitimacy perspective, this study helps to address this gap in sustainability-related research.

The remainder of this paper is organized as follows. Section 2 presents the theoretical framework of the study and devel- ops the hypotheses. Section 3 describes the variables and the sample. Sections 4 and 5 present the empirical findings. Sec- tion 6 discusses the main results and concludes.

2. Theoretical framework, literature review and hypotheses development

2.1. Legitimacy and the social contract

As noted by Gray et al. (1995), a large body of social and environmental accounting research is grounded in legitimacy theory. Dowling and Pfeffer (1975, p. 122) define organizational legitimacy as the ‘‘congruence between the social values asso- ciated with or implied by their activities and the norms of acceptable behavior in the larger social system of which they are a part”. The concept of a social contract established between organizations and society is central to legitimacy theory (e.g., Cho, 2009; Deegan, 2002; Deegan and Blomquist, 2006; Hooghiemstra, 2000; Patten, 1992). Shocker and Sethi (1973) argue that all organizations are linked to society by a social contract, and it can be viewed as an ‘‘ethical floor below which firms cannot fall and still be considered socially legitimate” (Van Buren, 2000, p. 210). Therefore, organizational legitimacy and social con- tract compliance go hand in hand (Deegan et al., 2000), and a breach of the contract may lead to a perception by society that the organization is not legitimate.

According to Suchman (1995), prior literature defines organizational legitimacy from two different perspectives. First, from a strategic perspective, legitimacy is considered to be a resource on which an organization is dependent for survival (Dowling and Pfeffer, 1975; Deegan, 2002), and legitimacy can also be influenced or manipulated by organizations to gain societal support. Second, from an institutional perspective, society generates ‘‘cultural pressures that transcend any single organization’s purposive control” (Suchman, 1995, p. 572) and thus managers’ practices are constructed by external institu- tions. Suchman (1995) concludes that both strategic and institutional perspectives need to be considered in order to

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understand the complexity of organizations. Organizational legitimacy is thus the result of both managers’ active strategies and managers’ passive responses to external pressures.

Prior research suggests that firms facing legitimacy threats engage in specific disclosure strategies to alter perceptions about the legitimacy of the organization (e.g., Beelitz and Merkl-Davies, 2012; Cho, 2009; Cho and Patten, 2007). Legitimacy theory has been extensively used in the previous literature to explain firms’ disclosure strategies in non-routine situations (Merkl-Davies and Brennan, 2007) such as (1) corporate scandals (e.g., Breton and Côté, 2006; Elsbach, 1994), (2) environ- mental disasters (e.g., Beelitz and Merkl-Davies, 2012; Cho, 2009; Deegan et al., 2000; Hooghiemstra, 2000; Patten, 1992), and (3) restructuring firms (e.g., Arndt and Bigelow, 2000; Mäkelä and Näsi, 2010; Ogden and Clarke, 2005). Disclosures are regarded as responses to both public pressure and increased media attention (Hooghiemstra, 2000), which are particu- larly strong in the context of downsizing operations (Henderson et al., 2010).

2.2. Downsizing operations

Proactive downsizing operations aim to improve the efficiency and profitability of firms (Freeman and Cameron, 1993; Pouder et al., 2004; Sheaffer et al., 2009) and/or to maintain competitiveness (Lee, 1997), and they are generally imple- mented without apparent financial needs (Love and Kraatz, 2009). In contrast, reactive operations are carried out because of poor or declining firm performance (Lee, 1997; Worrell et al., 1991). Several studies (e.g., Abraham, 2004; Chen et al., 2001; Elayan et al., 1998; Hillier et al., 2007; Lee, 1997; McKnight et al., 2002; Worrell et al., 1991) document that the market reaction is more negative when downsizing operations are reactive compared to when they are proactive, while others report a positive reaction to proactive operations (Abraham, 2004; Elayan et al., 1998; Gunderson et al., 1997; Hahn and Reyes, 2004; McKnight et al., 2002). From an economic perspecti