Corporate Diversification and Downsizing Decisions: International Evidence from Sharp and Sudden Performance Shocks

Abstract

While firms regularly reduce workforce following sharp performance decline, diversified firms may abstain from employment downsizing by transferring capital and labor between segments (the allocative flexibility effect). However, downsizing may be more likely if a performance shock leads to efforts to reduce inefficiency in resource allocation (the inefficient internal market effect). Using a large cross-country dataset, our results provide strong support for the inefficient internal market effect. We find that diversified firms are more likely to downsize and the national employment protection and union power laws moderate this link. We also find that diversified firms with more excess employment are more likely to downsize and that downsizing following major adverse performance shocks is associated with lower level of diversification and excess employment.