Peer Effects in the Timing and Inflation of Restructuring Charges: Evidence from Economic Recessions

This paper proposes that when faced with a common economic shock, the timing of a firm’s restructuring actions relative to its peers influences the extent to which the firm’s managers create reserves, that is, inflate restructuring charges and reverse them strategically in the future. We rely on the relative timing of restructuring charges across industry peer firms during two major economic recessions – those in 2001 and 2008 – to identify firms that initiate restructurings early in recessions (Leaders) and those that follow their peer firms (Followers). Using reversals of restructuring charges to detect inflation, we find robust evidence that Followers’ charges are significantly more likely than Leaders to exhibit reversals. Moreover, the likelihood of reversals for Followers relative to Leaders is even higher when their pre-reversal earnings fall short of analysts’ consensus forecasts. Additionally, we document that the reversals for Followers exhibit a greater tendency to convert a shortfall with pre-reversal earnings to a meet/beat with post-reversal earnings. The results are robust to propensity-score-matching between Leaders and Followers on firm-specific characteristics. Further tests provide corroborating evidence that the restructuring charges of Followers are larger than those of Leaders after controlling for their economic circumstances, consistent with inflation.