The Truth About the Seven-Percent Rule

The New Yorker’s James Surowiecki recently devoted a column to the notorious “Seven Percent Rule.” For those unfamiliar with the phrase, it refers to the assumption that after a company announces major layoffs, its stock price will rise roughly 7% in an apparent correlation between employee downsizing and Wall Street enthusiasm. Surowiecki notes, however, that the rule’s validity took a hit recently when both Circuit City and Citigroup saw their stock prices fall after announcing lots of job cuts. His conclusion? The rule isn’t much more than a corporate myth.

He proceeds to debunk the idea that fewer employees, and thus lower payroll costs, equal higher profits, citing University of Colorado management professor Wayne Cascio‘s study of three hundred downsizing firms in the 1980s. The data indicated that, three years after the layoffs, profit margins, costs, and returns on assets hadn’t improved. While Surowiecki acknowledges that it’s possible the companies would have fared even worse had they failed to downsize, he concludes that the effects of layoffs on the average company’s profit margins seem negligible at best.