Companies that face performance shortfalls often seek organizational changes to improve their trajectory. Two main strategic avenues exist growth-oriented strategies like mergers, acquisitions, product diversification, and factory expansion, and corporate downsizing measures like divesting underperforming units, closing facilities, selling assets, and implementing layoffs.
While downsizing, particularly workforce reduction, is seen as a faster and simpler response to performance issues, it often comes with drawbacks. It can free up resources and improve efficiency, but it can also damage morale, harm external perception, and even reduce CEO compensation tied to firm size.
Despite these drawbacks, CEOs often hesitate to downsize, even when it seems necessary. This reluctance stems from the negative connotations associated with downsizing and the potential impact on their compensation.
A recent study by Wei Shi, Boshuo Li from the University of Miami, and Guoli Chen examined how a CEO’s internal attribution tendencies (the tendency to attribute outcomes to internal or external factors) affect their propensity to downsize in response to performance shortfalls.
How Attribution Biases Influence Downsizing Decisions
This research focused on internal attribution tendencies, a key cognitive trait that shapes how CEOs perceive their accountability for performance. Individuals with strong internal attribution tendencies tend to take personal responsibility for both positive and negative outcomes, while those with weaker tendencies blame external factors.
We hypothesized that CEOs with strong internal attribution tendencies would view performance shortfalls as their responsibility and proactively implement downsizing to rectify the situation, even if it harmed their short-term interests.
Conversely, CEOs with weaker internal attribution tendencies would likely blame external factors like economic conditions, competition, and regulations for poor performance. They might resist downsizing due to its perceived negative consequences and their own limited perceived ability to improve performance. They might also see downsizing as an admission of past mistakes and avoid it to escape blame.
Embracing or Evading Responsibility
Using the awareness-motivation-capability (AMC) framework from competitive dynamics research, we argued that a CEO’s internal attribution tendencies influence their acknowledgment of responsibility for performance shortfalls and their willingness to downsize. This influence is even stronger when CEOs face increased scrutiny from financial analysts or unfavorable external conditions.
Our analysis of data from 3,977 CEOs of 2,424 publicly listed US firms from 2002 to 2013 supported our hypotheses. We found that CEOs with stronger internal attribution tendencies were more likely to downsize after performance shortfalls, while those with weaker tendencies were less likely. This effect was even more pronounced when CEOs faced more analyst scrutiny or unfavorable external environments.
Heeding CEO Attribution Biases
This research has implications for both corporate boards and executives. It highlights the importance of understanding a CEO’s internal attribution tendencies, as CEOs with weaker tendencies might be less likely to downsize when necessary. This reluctance could hinder a company’s turnaround efforts if internal reforms are not implemented.
While our study focused on performance shortfalls, its implications extend beyond downsizing decisions. CEOs with weaker internal attribution tendencies might also be more likely to blame external factors for corporate misconduct or customer dissatisfaction, neglecting internal issues that need improvement.
Recommendations
- Boards: Increase oversight to ensure CEOs consider downsizing when facing performance challenges. When selecting CEOs, consider psychological traits like attribution biases, not just charisma.
- Executives: Assess your internal attribution tendencies to identify potential decision-making biases and broaden strategic options. Consider pairing executives with contrasting internal tendencies in top management teams.
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Conclusion
This research sheds light on the complex dynamics of corporate downsizing decisions. By understanding and addressing the cognitive biases that influence CEO behavior, organizations can make better decisions and navigate challenges more effectively. It also emphasizes the importance of fostering a culture of accountability within organizations, where individuals are encouraged to acknowledge their role in both successes and failures, leading to continuous learning and improvement.
