The effect of advance notice of plant closings on firm value
Sharon K. Clinebell
An important issue in the 1980’s was the issue of displaced workers. Displaced workers are defined as “individuals who had three of more years of tenure with their employer and who lost a job due to either a plant or business closing or moving, slack work, or the elimination of their position or shift” (Herz, 1990, p. 22). Using this definition, 4.6 million workers were displaced between 1983 and 1988 (Herz, 1990). Workers who lost their jobs due to plant closings accounted for 57.9 percent of those displaced workers or approximately 2.7 million workers. The large number of displaced workers has brought the issue of advance notice increased attention. One area of interest is what effect, if any, the amount of advance notice of plant closings has on firm value.
Given the potential strategic management and financial implications advance notice has for companies, an interdisciplinary approach will be used to examine the effect of advance notice of plant closings on organizations. An interdisciplinary approach regarding issues of concern to both disciplines has been encouraged by many researchers (Jemison, 1981; Bettis, 1983; Peavy, 1984). Additionally, Lubatkin and Shrieves (1986) and Rappaport (1981) argued that stock prices are important strategic variables. The purpose of this paper is to examine the effect, if any, that advance notice of plant closings has on firm value. Subsequent implications for strategic management also will be discussed.
There are two divergent streams of research concerning plant closings, layoffs and related firm activities. The first stream of research examines the human costs of these activities. This research approach uses an individual level of analysis. It has been found that individuals who lose their jobs have negative attitudes, adverse health consequences, increased alcoholism, and reduced psychological well-being (Brenner & Bartell, 1982; Burke, 1985; Iversen & Sabroe, 1988; Liem & Liem, 1988; Kessler, Turner & House, 1988; Warr, Jackson & Banks, 1988; Dooley & Catalano, 1988). An area in Pennsylvania that lost 20,000 steel jobs reported suicide rates twice the national average, a divorce rate among the jobless that is double that of the employed, and growing incidences of domestic violence (Thompson, 1985).
The major advantage of advance notice is the time it gives workers and the communities to adjust to the loss of the plant. With this time, workers could look for other jobs, enter retraining programs and watch their finances more closely. Studies have examined the impact of advance notice on length of time without work experienced by displaced workers and on their subsequent earnings (Addison & Portugal, 1987; Love & Torrence, 1989). It was found that advance notice reduced the duration of time without work, but no impact on subsequent earnings was found. Another advantage of advance notice is that communities would have the opportunity to attempt to attract other businesses. Opponents of advance notice legislation list impaired efficiency of the work force, apathy on the part of workers concerning their job and the company, increased potential for sabotage, and the premature attrition of the work force as the disadvantages of advance notice (Weber & Taylor, 1987). One fear is that the orderly shutdown of the plant would be affected. However, studies have shown that productivity is not affected (Weber & Taylor, 1987) or is even improved after notice is given that plants are closing (Wall Street Journal, November 11, 1988). The improvement in productivity is related to lingering hopes that good performance can save the plant and also hopes for good recommendations for future employment opportunities.
The second stream of research is concerned with the financial costs and uses a firm level of analysis. Brickley and Van Drunen (1990) examined the effect of internal corporate restructuring on firm value. Unit liquidations were included as forms of internal restructuring. They found positive market reactions to restructuring whether it was due to undertaking expansion opportunities or to improve efficiency.
Statman and Sepe (1989) examined the effect of project termination announcements on the value of the firm. Their results indicated that stockholders responded positively to project termination announcements, especially if there had been prior information concerning the poor prospects of the project. Statman and Sepe suggested that stockholders were happy that they would no longer be supplying money to a project with an unfavorable future.
Worrell, Davidson and Sharma (1991) examined the effect of layoff announcements on stockholder wealth. They found a negative effect on stockholder wealth to layoff announcements attributable to financial reasons. Worrell et al. suggest that stockholders may view layoffs as a signal of financial distress.
Blackwell, Marr and Spivey (1990) found significant negative announcement effects only for plant closings that managers attribute to unprofitable operations. They also found a significant negative market reaction to unanticipated plant closing announcements. They found no significant reaction for anticipated announcements. Blackwell et al. (1990) also found a positive market reaction to plant closing announcements if the market was aware that managers were operating unprofitable plants.
There are some inconsistencies in the findings of these studies. While Brickley and Van Drunen (1990) found that restructuring is reacted to positively, Worrell et al. (1991) found that layoffs are viewed negatively by stockholders. Statman and Sepe (1989) results showed that stockholders reacted positively to project terminations. The mixed results of these studies may be due to the differing impacts of the informational content of the events and cash flow effects. No research to date has explicitly examined the effect of timing of plant closings on firm value. The purpose of this study is to examine the effect of advance notice of plant closings on firm value.
Foundations for Study
Firm valuation theory provides a foundation to understand the effects of announcements, such as plant closings, on firm value. According to Fama and Miller (1972), a firm’s value increases when its expected cash flows increase or its systematic risk decreases. Plant closing announcements may have several different effects on firm value. First, the announcement may be viewed as a signal of financial distress by the firm with a resulting decline in firm value. However, the announcement may also be viewed as a positive development. The announcement may indicate that management is taking the necessary steps to increase the firm’s cash flows by closing unprofitable operations. The results of the research discussed previously, although mixed, would tend to support a negative effect on firm value due to the signal of financial distress.
The major issue examined in this research is the effect timing of plant closings may have on an organization. The negative effect due to a signal of financial distress should impact all plant closing announcements regardless of when the closing will take place. Thus, the effect of delaying plant closings on the firm’s cash flows may be a critical issue. A delay in closing an unprofitable operation would be expected to have a negative impact on cash flows. Based on valuation theory, firms that give more advance notice should experience a greater decline in firm value than would be expected from the signal of financial distress alone, while firms that give less advance notice should have the negative effect somewhat mitigated.
Another possible impact of advance notice on firm value may arise from how the actions of the firm are viewed by stakeholder groups such as employees, suppliers, and the community. As the research discussed previously has demonstrated, plant closings may have significant negative effects on the employees, communities, and other stakeholders directly affected by the closing. It may be that by giving more advance notice a firm can work with the affected stakeholder groups to minimize the impact of the plant closing. By taking these actions and allowing stakeholders more time to adjust to the closing, the firm may build up goodwill which may result in their stock being viewed in a more favorable light thereby minimizing the negative effect that may occur from the closing announcement.
Specifically, if a plant closing is viewed as a signal of financial distress, a negative impact on firm value should result. If there is a cash drain effect from delaying the plant closing, the impact on firm value should be more negative for those companies giving sixty days or greater advance notice. If a reputational effect is present, the impact of firm value should be less negative for those companies giving sixty days or greater advance notice.
An initial search of The Wall Street Journal Index was conducted for the years 1980 through 1988 to find announcements of plant closings. This time period was selected in order to include both plant closing announcements that were effective in less than sixty days as well as sixty days and greater. Because not all announcements give the exact days until the closing, it was necessary to categorize the amount of advance notice given in the announcement in order to maintain a reasonable sample size. The passage of recent legislation which requires sixty day advance notice provides a useful means of categorizing advance notice, sixty days and greater or less than sixty days. However, for an announcement to be included in the sample, the following criteria had to be met:
1. The announcement date and the time period in which the plant closing would be effective were available.
2. The plant closing was due to financial reasons (i.e., unprofitable operations at the plant level). Plants closed because of technological changes, temporary layoffs, strike activity, or environmental reasons were not included in the sample.
3. There could be no announcements within plus or minus five days of the plant closing announcement, which might confound the results such as earnings announcements, dividend announcements, layoff announcements, or other major announcements that might affect the firm.
4. The firm announcing the plant closing was traded on the New York or American stock exchanges.
5. Continuous daily returns for both the estimation period and the test period were available on the Center for Research on Security Prices (CRSP) data tapes.
6. Firm capitalization and number of employees were available on the COMPUSTAT data tapes.
These screening criteria were selected to control for exogenous variables and to insure full data availability. The sample was also screened for any potential industry effects.
The initial search of the Wall Street Journal Index resulted in over four hundred plant closing announcements. However, after applying the screening criteria identified above, the final sample consisted of 98 announcements. The final sample consisted of firms from forty-eight different industries (industry groupings were determined by the first three digit of the industry number using the SIC codes). Further, no one industry accounted for more than five of the plant closing announcements. Although requiring the firms to meet these criteria reduces the sample size, control over variables such as reason for the closing, industry, and other exogenous variables is achieved.
To examine the effect of advance notice on firm value, the daily stock return event methodology (Brown & Warner, 1985) was utilized to determine if abnormal performance was associated with the differing degrees of advance notice. The residual returns (RES) during the test period are calculated for each security using the following model:
[RES.sub.i,t] = [R.sub.i,t] – ([a.sub.i] + [b.sub.i][R.sub.m,t]) (1)
where [R.sub.i,t] is the return for a security on day t and [R.sub.m,t] is the return on the CRSP equally weighted market index on day t. A residual is the excess return (i.e., actual return — expected return) associated with a firm’s stock. A negative residual would indicate that the firm’s stock has experienced a loss in value relative to its expected level of performance. The coefficients [a.sub.i] and [b.sub.i] are estimated using ordinary least squares regression over the estimation period. The test period consisted of the announcement date (Day 0) and the five trading days prior to and the five trading days after the announcement date (Days -5 through +5). The estimation period consisted of the two hundred trading days prior to the test period. This period offers sufficient observations to estimate the parameters while minimizing the risk of historical distortions.
Average residuals (AR) for the test period are calculated as follows:
[AR.sub.t] = (1/n) [summation of] [Res.sub.i,t] where i=1 to n (2)
where n is the number of observations. Since the average residuals are composed of residuals from different time periods and different companies, some control over exogenous shocks is obtained. The expected value of the average residuals is zero, unless the event is significant.
In addition to average residuals, cumulative average residuals (CARs) are also analyzed. They are calculated as follows:
[CAR.sub.i] = [summation of] [AR.sub.it] where i=1 to n (3)
By examining the pattern of the CARs, the tendency of residual returns to move in a specific direction is identified. CARs should not be significantly different than zero if no effect is present.
This methodology allows the average reaction of stockholders to a specific event, such as plant closings, to be isolated. This procedure has been used to study the effect of many events that may impact the firm. For example, this methodology was used to examine the effect of managerial turnover due to death (Worrell, Davidson, Chandy & Garrison, 1986), strike activity (Davidson, Worrell & Garrison, 1988), layoffs (Worrell, Davidson & Sharma, 1991), corporate illegalities (Davidson & Worrell, 1988), cabinet appointments from top management (McGuire, Schneeweis & Naroff, 1988), CEO changes (Lubatkin, Chung, Rogers & Owers, 1989), the release of earnings information (Ball & Brown, 1968), dividend changes (Charest, 1978), and corporate divestiture (Montgomery, Thomas & Kamath, 1984).
Table 1 provides the results for the sample of firms that met the sixty day advance notice criteria and the sample of firms that provided less than sixty days advance notice. For the sample of firms providing less than sixty day notice, the average residuals are not significantly different than zero except for the day immediately following and the fifth day following the announcement. For the sample of firms providing sixty days or more advance notice, there are significant negative returns on both the announcement date and the day following the announcement at the .10 and .05 levels respectively. However, a significant positive residual occurs two days prior to the announcement. Due to the mixed results, an analysis of the cumulative average residuals is required. As shown in Table 2, the cumulative average residuals for time period immediately around the announcement date are significantly negative for the sample of firms that gave sixty or more days advance notice. For the firms providing less than sixty days notice, the CARs, although negative, are never significantly different than zero. For the total test period the CARs for both samples are not significantly different than zero.
The lack of significant negative CARs for firms that gave less than sixty days advance notice indicate the cash drain effect associated with timing that was proposed may be moderating the signal of financial distress for those firms that acted quickly in closing the plant (i.e., closing the plant within sixty days of the announcement), thereby minimizing the potential cash flow drain associated with the continued operation of the plant. A firm’s announcement of a plant closing signals that the firm is experiencing problems and results in a decline in firm value. However, by acting quickly to minimize the potential financial losses, the effect of the signal is moderated. The significant negative CARs for the firms that gave 60 days or greater advance notice would appear not to support the postulated reputational effect on firm value.
Table 1. Average Residuals and Cumulative Average Residuals for the Advance
Notice Time Periods of Less than 60 Days and Greater tlan 60 Days
Less than 60 Days(a) 60 Days and Greater(b)
Days(c) AR(d) z-Score CAR(e) AR(d) z-Score CAR(e)
-5 -0.0011 -0.325 -0.0011 -0.0021 -0.828 -0.0021
-4 0.0047 1.366 0.0036 0.0005 0.206 -0.0016
-3 0.0049 1.431 0.0085 -0.0007 -0.274 -0.0023
-2 -0.0020 -0.590 0.0065 0.0044 1.770(**) 0.0021
-1 -0.0008 -0.222 0.0057 -0.0014 -0.578 0.0007
0 -0.0030 -0.884 0.0027 -0.0039 -1.570(*) -0.0032
1 -0.0058 -1.688(**) -0.0031 -0.0051 -2.042(**) -0.0083
2 -0.0015 -0.431 -0.0046 0.0014 0.540 -0.0069
3 -0.0043 -1.244 -0.0089 0.0030 1.182 -0.0039
4 0.0027 0.784 -0.0062 0.0017 0.687 -0.0022
5 -0.0056 -1.660(**) -0.0118 -0.0024 -0.967 -0.0046
a Less than 60 days n = 34
b Greater than 60 days n = 64
c Day 0 = Announcement Date
d AR = Average Residual
e CAR = Cumulative Average Residual
* p [is less than or equal to] .10
** p [is less than or equal to] .05
Table 2. Cumulative Average Residuals for Selected Time Intervals around the
Announcement Date for Companies that Gave Less than 60 Days Notice and
Companies that Gave at Least 60 Days Notice
Less than 60 Days Notice At Least 60 Days Notice
Interval CAR z-Score(a) CAR z-Score
-1 to +1 -0.0096 -1.616 -0.0104 -2.399(*)
-5 to +5 -0.0118 -1.040 -0.0046 -0.554
Notes:* p [is less than or equal to] .01
a See Brown and Warner (1985) for a discussion of the test statistic.
Although the screening criteria used to select the sample controlled many variables such as the reason for the closing and other announcements during the test period, the above results could be influenced by other factors. Two major factors that might influence the results may be the relative number of employees affected by the plant closing and the size of the firm as measured by market capitalization. A plant closing that affects a large percentage of employees would be expected to have a greater impact on firm value than a closing that affects a relatively small percentage of employees. Further, a firm with high capitalization may be less affected by a closing announcement than a smaller firm. To further test whether timing has a significant impact on firm value or if these other factors are influencing the results, the following regression model was constructed.
[CAR.sub.i,t] = [b.sub.0]+ [b.sub.1](TDUM) + [b.sub.2](CAP) + [b.sub.3](EMPLY) + [e.sub.i,t] (4)
where: [CAR.sub.i,t] = the cumulative average residual for company i in time period t.
TDUM = a dummy variable with a value of 1 when less than sixty days notice was given and 0 when sixty or more days notice was given.
CAP = the relative size of the firm’s market capitalization measured by the ratio of the firm’s market value to the average market value of the sample.
EMPLY = the size of the plant closing relative to the size of the firm. This was measured by the percentage of the firm’s employees affected by the plant closing.
The means, standard deviations, and correlations for the variables in the regression model are presented in Table 3 and the results for the regression model are shown in Table 4. The correlations shown in Table 3 indicate a strong relationship between CARs and the timing variable and little relationship between CARs and the other test variables. Although small there is a significant negative correlation between the level of capitalization and the timing variable, indicating that larger firms may tend to give more notice.
The regression model was estimated for both the period immediately surrounding the announcement (days -1 to +1) and for the entire test period (days -5 to +5). The results for both estimations confirm the impact of timing on firm value. In both cases the dummy variable representing whether the plant closing was less than sixty days or sixty days or greater was significant and positive. The positive coefficient of the dummy variable indicates that the firms that gave less than 60 days notice reduced the negative impact on firm value of the plant closing announcement. This result supports the postulated moderating effect associated with timing due to a cash drain, but not the goodwill or reputational effects. To illustrate this effect assume firm A gave less than sixty days notice and had a CAR of -.01 and firm B gave more than sixty days notice and had a CAR of -.04. Although both firms experienced a negative signal of financial distress, firm A experienced a moderating effect associated with timing of +.03. Although both the size of the closing, as measured by the percentage of affected employees, and level of capitalization were of the expected sign, neither were significantly different than zero.
Table 3. Means, Standard Deviations and Correlations for Regression Variables
Variables M SD 1. 2. 3. 4.
1. CAR .1116 .2044 — .6921(*) -.0759 -.0529
2. TDUM .3463 .4760 — .1466(*) -.0559
3. SIZE .1450 .2173 — .1301(*)
4. EMPLY .0818 .3327 —
Notes: * p [is less than] .01
N = 1078
Table 4. Effects of Advance Notice, Capitalization, and Percentage Employees
on Firm Value(a)
Period Variable Parameter Estimates(b)
-5 to +5(c) Advance Notice 0.298(**) (31.138)
Capitalization 0.023 (1.094)
% of Employees -0.007 (-0.491)
-1 to +1(d) Advance Notice 0.033(*) (1.630)
Capitalization 0.029 (0.645)
% of Employees -0.033 (-1.130)
* p [is less than] .10
** p [is less than] .01
a t-values are shown in parentheses
b Model: [CAR.sub.i,t] = [b.sub.0] + [b.sub.1]TDUM + [b.sub.2]CAP +
[b.sub.3]EMPLY + [E.sub.i,t]
c 11 observations per company for 98 companies yielding a total n = 1078
d 3 observations per company for 98 companies yielding a total n = 294
The results of this study indicate that the amount of advance notice given for plant closings may have a significant effect on the performance of the firm’s stock. Potential reasons for these findings rest with the expectations of stockholders. By announcing a plant closing, the firm is admitting that problems exist. Although the results in this paper tend to reinforce a negative signal of financial distress, the only CAR with a significant negative result was immediately surrounding the announcement date for those companies that gave sixty days or greater advance notice. Although other CARs were negative, the results were not significantly different than zero. However, the results of the regression suggest that stockholders may assume that the longer the plant remains open, the greater the negative impact on the firm’s cash flow. For example, the plant may be a cash drain on the organization. Stockholders may assume that productivity will decline further, labor problems will increase, and turnover will increase as the employees find new jobs. Whether these assumptions are correct or not, they are filtered into the process of valuing the firm’s stock. Some possible implications of these stockholders’ perceptions include an impairment of the firm’s ability to raise capital and general dissatisfaction with the management of the firm.
What public policy implications do these findings hold? In response to the growing numbers of displaced workers due to plant closings, Congress passed the Worker Adjustment and Retraining Notification Act (WARN) in 1988. Although the results presented in this paper are not a test of WARN, it does appear that the amount of advance notice given for plant closings may have a significant effect on the value of the firm. Policy makers need to realize that there is a tradeoff between the negative effects on the firm and the positive benefits for employees and the communities in which these plants are located. These tradeoffs need to be examined very carefully before any further laws are passed. The negative impact on the value of the firm should be one factor to be considered when making these decisions.
What management implications do these findings hold? At face value, the findings would indicate that organizations should give the minimum notice for plant closings. However, again a tradeoff is present between the negative effects on the value of the firm and the positive effects on employees and communities. Management should examine the effects on the many stakeholder constituencies that include stockholders, employees, and the communities in which they are located. As is so often the case, different constituencies have varying, and often competing, needs. Advance notice for plant closings is another area in which management must weigh and balance these competing needs. The results of this study provides additional information to management of the potential effects on one stakeholder group. Both financial and ethical issues are present and each should be examined before making final decisions.
Management implications also might extend to other types of corporate bad news. It appears from this study that bad news should be dealt with as quickly as possible to minimize the negative effects. However, more research needs to be conducted on these issues.
Another avenue for future research is to expand the data base to include European companies. The issue of advance notice for plant closings emerged in Western Europe in the late sixties. Although European laws are criticized for the lack of penalty and enforcement (Harrison, 1987), given the longer time period in which advance notice requirements have been present in Europe, comparing the results for U.S. firms and European firms might provide interesting results.
The results of this analysis appear to indicate that the length of the advance notice given for plant closings may have a significant effect on the value of the firm. Although the announcement of plant closings tends to have a negative effect on performance, the results of this study indicate that the negative reaction may be mitigated by providing the minimum notice necessitated by legal and operational factors. It is important to note that this paper is addressing the effect of advance notice on the performance of the firm’s stock and not the behavioral or social effects of advance notice and that further study of the financial, social, and behavioral effects are required before definite conclusions can be drawn.
Acknowledgement: The authors express their appreciation to Spring Thompson for her work in the data collection process.
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