Does it matter whether a company is financed through equity or debt? And if so, to whom does it matter? Prior research has found that skilled employees begin making career changes just before their employer declares bankruptcy, but do they react to credit signals earlier than that? Research coauthored by Chicago Booth’s Jessica S. Jeffers finds that a credit downwatch, or a warning that a formal downgrade of a company’s credit rating may be imminent, sparks increased networking activity among the company’s employees on the social network LinkedIn. The findings suggest this activity is more pronounced for skilled and senior employees, who may have a greater financial or career stake in the company’s wellbeing, and that more networking doesn’t necessarily presage a change of employers. Rather, many employees may ramp up their networking efforts as a hedge against further financial concerns.
Jessica Jeffers: A central question in corporate finance is: Does it matter how the firm finances itself? Does it matter if the firm has debt or equity or any combination thereof?
And a big part of understanding that is trying to understand who cares about whether the firm has debt, for example. Equity holders will care, because the more debt there is, the riskier their equity gets. But it can also be good for them. Other stakeholders might care as well. So, for example, customers and suppliers and employees might care about whether the firm has a lot of debt and whether it looks like the firm is financially healthy or not. But because we tend to have less data on these kinds of stakeholders, it’s been harder for us to pin that down.
So what we were interested in, in this project, was trying to understand to what extent employees care or even notice the firm’s credit condition. And so, what we’re doing is we’re looking at events where the firm’s debt is placed on a negative credit watch. So this is a rating agency essentially saying, “We’re not downgrading your debt yet, but we think it’s looking not great, so we’re just putting you on a negative credit watch and we might downgrade you in a few weeks.”
And what’s really cool is that we have access to LinkedIn data—all anonymized, so we don’t know who anyone is but we know where they work. And so we can see when employees of a given company are initiating connections to other people on the LinkedIn platform. And what that allows us to do is to see whether they increase their connection activity at all when there is this kind of negative news about the firms credit condition.
So there’s been some recent evidence that especially talented and smart employees start to leave as the company gets really close to bankruptcy, and we were interested in understanding if that also happens at earlier signals. We’re looking at downwatches and also downgrades that aren’t necessarily the firm is going bankrupt in the next year, but they do signal deterioration in the company’s credit.
It wasn’t obvious to us initially whether we would see any reaction on the part of employees. Maybe employees don’t pay any attention to their employer’s credit ratings or any news about their employer’s credit condition. But what we find is that there is this very systematic uptick in connection activity when the firm experiences a credit downwatch or an unexpected credit downgrade.
We looked at other events. So first we looked at the flip side of the coin, positive credit watches, and we didn’t find any reaction in terms of connection activity in response to positive signals about the firm’s credit condition. And then we looked at other events that we thought also signaled something about how well the firm is doing economically. In particular, we looked at events when the firm misses its projected earnings by a lot, and we know that shareholders care a lot about that kind of event. They react a lot.
But when we look at employees’ connection activity, they don’t respond to that kind of news. So it does seem to be, so far, something that’s relatively unique to credit deterioration.
We wanted to understand whether this increasing connection activity reflects that employees are actually in the process of leaving or jumping ship. So as they interview and talk to people about potential job opportunities, that’s where we’re seeing the connections. Or whether it’s more of a precautionary thing, where they’re not necessarily planning to leave right now, but they wanna make sure that they have networks in place in case they want to leave in the future.
The evidence we see is more consistent with the latter. We find that both employees who end up leaving and employees who end up staying connect more in response to these negative credit events. And we don’t find that employees who connect more in response to these events are more likely to leave.
We also look at skilled employees versus less-skilled employees, and this is consistent with results that have looked at what happens immediately leading up to bankruptcy. We find that more-skilled employees react more to signals about the firm’s credit. In particular, we find that this effect is stronger for more-senior employees, which, again, is interesting because you might think that more-senior employees already know how well the firm is doing, and so they don’t learn anything new from the rating agency changing their opinion.
On the other hand, more-senior employees might have more of a stake in the firm’s financial health, whether that’s directly through compensation or indirectly through career incentives. And what we find is more consistent with the latter. We find that the more senior the employee, the more they tend to react to a credit downwatch or unexpected downgrade by increasing connection activity on LinkedIn.
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