This study examined the impact of downsizing—a practice that has attracted considerable attention both domestically and internationally—on innovation. Analysis of a sample of 189 listed Korean companies revealed that downsizing has a negative effect on innovation. Furthermore, an analysis of the moderating effects of contextual variables—including managerial change orientation, environmental dynamism and munificence, organizational structure, and characteristics of downsizing firms—on the relationship between downsizing and innovation showed that only environmental munificence and downsizing firm characteristics had significant effects. Through this study, we learned that downsizing leads to a decline in innovation and can potentially undermine competitiveness in the long run, and that its negative effects can be particularly pronounced in firms facing unfavorable internal and external conditions. Additionally, we discovered the practical implication that firms should exercise caution in adopting downsizing practices, and when they do, they should devise separate measures to promote innovation.