Layoffs: The questionable logic of the US human capital orientation
As Sanjay returned his laptop issued by his company, key card, and signed termination agreement, he could not help but wonder, “How am I going to explain this to my parents back home?” After graduating at the top of his class in a prominent university, he had multiple offers to join top tech firms in Silicon Valley. He followed his father’s advice and joined a more established firm and seemed to be all set for a great career. In fact, his parents boasted about his success to everyone in the family and in their local community. However, now he faced the challenge of trying to explain the news of his layoff to his family and friends.
For Sanjay and thousands of others, the news of one’s employment being terminated is a very personal and often devastating experience. Yet, from a company perspective it is often anything but personal – just business. So far in 2023, more than 170,000 employees have been laid off in the US tech sector alone. From an outsider’s view, it may seem strange that firms have access to advanced AI, analytics, and sophisticated business modelling tools, yet they cannot determine how many people they might need in their organisation! However, in the context of employment regulation, human capital costs, and financial markets, there is a complex dynamic behind company layoff announcements. Let’s take a closer look at the human capital orientation in the US business environment to understand this dynamic.
Accounting for Human Capital
While we can often hear business executives say, “People are our most important asset,” the accountants might disagree. After all, there is not a place on the balance sheet for human capital and the investment in developing people is nothing more than another expense. My colleague, Peter Cappelli at the Wharton Business School, has long been an advocate of changing the accounting rules established by the Financial Accounting Standards Board. As Cappelli notes, employees with years of valuable knowledge and unique talent in the business are viewed from an accounting standpoint as expenses – or potentially even as liabilities.
While this is not unique to the US, there is a heightened orientation to labour costs following decades of outsourcing, off-shoring, and automation. Ironically, this focus on lower labour costs also comes during a period of dramatic rise in executive pay packages, feeding the rising inequality in pay practices. While we continue to see evidence that business leaders believe in the value of strategic human capital for competitive advantage, we cannot help but question the logic of not accounting for this as an asset in the US businesses.
Employment at Will
US employment law is based on the concept of “At Will Employment.” This is designed to allow workers to freely leave employers without reason or even a notice period. The reciprocal arrangement is also true, which allows employers to terminate employment without reason and generally without much notice (unless there are large numbers of layoffs from a firm as this may trigger a federal WARN Act, which requires employers to provide a 60-day notice). The US is one of the few countries that has such a system where an employee can be terminated for a particular reason or for no reason at all (barring unfair employment practices).
While most other countries have restrictions and provisions that protect employees, the US system is rather unique, which may reflect the individualistic culture of the nation. Yet, even with such regulatory freedom afforded by the At Will employment provision, it seems counter-productive for businesses and HR leaders to work hard to attract talent one year – only to engage in lay-offs the next year!
Financial Market Expectations
For public firms with stock traded on one of the exchanges, there is always sensitivity to the markets and the shareholders who hold equity positions in the firm. When economic factors such as interest rates, currency values, inflation, and other such changes begin to affect business financial performance, business leaders are often faced with significant pressure to make adjustments that will lessen any adverse financial impact.
Given the human capital accounting treatment and employment at will construct, it is perhaps not surprising that leaders often turn to reducing labour costs. In fact, the financial markets seem to reward job cuts as evidenced this year with most stocks rising over 5% following firm announcements of layoffs. This is even the case when firms may indicate that there may be a one-time restructuring charge to take this action. Even though the long-term evidence does not support the link between downsizing and improved financial performance, it seems clear that the financial markets are viewing layoffs as a signal that the firm is taking good measures to drive more efficiency in the operations. Yet, the logic seems questionable without a clear understanding of what staff reductions are being made and if the firm may actually be losing valuable human capital assets.
Personal and Organisational Impact
Even with a system that allows US companies to jettison employees, the lasting negative impact of layoffs has been well documented at both an individual and organisational level. Of course, having one’s employment terminated can be devastating to an individual financially, but such an event can take an emotional toll on the individual. Research has shown that people can lose their sense of self-worth, confidence, and motivation, which can all lead to mental health issues such as depression and anxiety.
What is sometimes not fully understood is the organisational impact with the “Survivors” of layoffs. A reduction in workers can cause others to pick up additional workloads, which may increase anxiety and stress. The layoff experience inside an organisation can also erode the trust between the employer and employees – especially when the perceived handling of terminations is so abrupt (e.g. some firms recently notified employees with only an email). This is ironic at a time when employers have been concerned about addressing employee well-being, creating an environment of psychological safety, and fostering a sense of belonging in the work culture. Given the devastating impact of layoffs, the logic of actively engaging in short-term job-cuts as a relatively straight-forward business action seems questionable.
Given these dynamics, we are likely to continue to see prosperous economic times boost the hiring of talent, while lean economic times result in layoffs in the US. For people like Sanjay, understanding the dynamics of human capital accounting, employment at will, and financial markets does not help with his personal situation – nor will it help him explain why he was laid off to his parents!
After all, the logic of these systems seems questionable when we consider the long-term nature of human capital as an asset of a firm and evaluate the organisational impact and effectiveness. Perhaps it is time for a new human capital orientation in the nation that prides itself as a champion of human rights and the human condition!