Why the EU Needs a Better Measure of the Cost of Failure
Restructuring costs are a greater concern for innovative firms than for other firms, but surveyed firms overall cite uncertainty and data-protection rules more often as the main barrier to innovation. A commentary by Pietro Galeone, and Giorgio Presidente
Two years after Mario Draghi’s report on European competitiveness, the pressure to turn diagnosis into action is growing. Business leaders want fewer obstacles to investment, governments want faster growth, and Europe’s technology gap remains a source of concern.
The urgency of reform makes it more important to establish which constraints matter most.
Consider the argument that Europe makes failure too expensive. Innovation requires experimentation, and experimentation produces unsuccessful projects. If abandoning them entails large financial and legal penalties, companies will undertake fewer risky investments. Employment protection, by raising the cost of dismissing workers, could therefore discourage precisely the innovation Europe needs.
But how much does restructuring actually cost? How much of the bill comes from dismissal rules? And how important is it relative to other barriers to innovation?
Our new pilot survey offers some preliminary answers. Working with survey provider Dynata, we collected responses from 200 firms, heterogeneous across size, sector and nationality: 50 each in the US, Denmark, Germany and Italy. These countries span markedly different labour-market arrangements, from American flexibility through Danish flexicurity to the stronger employment protections associated with Germany and Italy.
Respondents were owners or senior executives involved in investment and innovation decisions. Half of the firms had at least 250 employees. 124 of them reported undertaking restructuring during the previous five years.
Rather than infer their costs from national regulatory indices or published accounts, we asked firms directly about their restructuring experience.
Crucially, we separated mandatory dismissal costs from voluntary employee payments and expenses unrelated to employees, such as asset write-offs and consultancy fees.
We also asked how many workers were dismissed, allowing us to calculate costs per worker and express them in months of pay using national average salaries.
A restructuring charge in a company’s accounts can include closing facilities, writing down assets and negotiating voluntary departures. Published figures may cover several countries. They are informative about corporate adjustment, but do not necessarily measure the costs imposed by a particular country’s dismissal legislation.
Our estimates of mandatory dismissal costs were equivalent to about one month’s salary in Denmark, 1.8 months in the US, 3.6 in Germany and 5.1 in Italy. While these results confirm that strict employment protection in Germany and Italy is responsible for a higher cost of restructuring, the estimates for Germany and Italy are an order of magnitude below those reported in earlier research using company disclosures.
We obtain figures closer to those earlier estimates only when we include all restructuring expenses and focus on the most expensive quarter of plans. This suggests that disclosed charges may be more informative about exceptionally costly corporate reorganizations than about the typical cost of collective dismissals.
We also asked firms to rank eight potential obstacles to innovation. To reduce the risk of prompting a particular answer, this exercise came before the questions about restructuring, with the barriers presented in random order.
Only 13.5% identified restructuring costs as their main obstacle. Economic uncertainty was more frequently cited, as was data-protection regulation. Access to finance and talent, alongside other regulatory requirements, also featured prominently.
There is an important qualification. Among high-tech firms, 28% put restructuring costs first, compared with about 10% in other sectors. This is consistent with the argument that businesses pursuing riskier projects are especially sensitive to the cost of abandoning them.
However, firms in Germany and Italy were not more likely than those in the US and Denmark to identify restructuring costs as their principal barrier. This suggests that the difficulty of reorganizing a business cannot simply be equated with the strictness of employment protection.
These findings warrant caution. The survey is a pilot, not a representative picture of the four economies. Only 36 respondents operate in high-tech sectors. Costs are self-reported, and national average salaries are an imperfect measure of the pay of dismissed workers. The small sample cannot be used to perform meaningful statistical inference.
Nonetheless, our results show that measurement matters. We need a larger, representative survey that distinguishes legal obligations from other adjustment costs and captures differences across countries, sectors and firms.
Also needed is a deeper academic discussion of what restructuring costs actually comprise and what drives them. The relevant literature remains fragmented across disciplines, which often examine different parts of the same problem.
Legal scholars tend to focus on the rules governing dismissal, insolvency, creditor rights and corporate restructuring; economists more often study how employment protection and other market frictions affect firm dynamics, resource reallocation, productivity and innovation; finance and entrepreneurship research examines financing constraints, bankruptcy and the downside risks associated with business failure.
It would therefore be valuable to create a forum in which scholars from different disciplines, together with practitioners, can compare concepts, evidence and measurement approaches.*
It is widely argued that stringent regulation in Europe raises the cost of failure and puts the EU at a disadvantage in innovation.
But dismissal rules are only one part of that cost, and our findings suggest they may not be the main obstacle firms face.
The priority should therefore be to identify which regulations actually make experimentation, failure and restructuring more costly.
A previous version of this article was published by the Italian daily Affari e Finanza - La Repubblica
IEP Bocconi does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
