Empirical evidence on shareholder value effects of corporate restructuring

Table of Content

1 Introduction

2 Fundamentals of Corporate Restructuring – Terms and Definitions
2.1 How to Measure Shareholder Value Creation
2.2 Corporate Restructuring – Definitions and Classifications
2.2.1 Portfolio Restructuring
2.2.2 Financial Restructuring
2.2.3 Organizational Restructuring

3 Empirical Evidence on Value Creation of Corporate Restructuring
3.1 Portfolio Restructuring and Shareholder Value
3.1.1 Mergers and Acquisitions
3.1.2 Spin-Offs
3.1.3 Sell-Offs
3.2 Financial Restructuring and Value Creation
3.2.1 Share Repurchase
3.2.2 Management Buy-Outs (MBOs) and Leveraged Buy-Outs (LBOs)
3.3 Organizational Restructuring and Value Creation
3.3.1 Layoffs, the effect of downsizing a company
3.3.2 Organizational Restructuring of Company Divisions

4 A Guideline to Value Creation
4.1 Information Policy
4.2 Consistency

5 Conclusion and Implications

1 Introduction

The rapid changes in the external environment, a very volatile and vulnerable business cycle, as well as changes in technology, capital structure and increased global competition have created revolutionary changes in management.

Organizations are repeatedly challenged to modify their strategies and reorganize and streamline their business to satisfy their shareholders and to enable their company to weather through the mentioned challenges of the recent past.

An increasingly favored way of enhancing the company’s value is to reorganize and restructure the firm’s business. In doing so, American corporations were able to create roughly $162 billion of shareholder value within only five years (Black & Grundfest, 1998).

However, controversy over the desirability of corporate restructuring has arisen because of the effectiveness and efficiency of the “newly invented” firms. Proponents argue that leaner and more efficient organizations arise after being restructured, while critics assert that organizational disruption exceeds the anticipated benefits from such transactions and therefore is a method of destroying shareholder value.

The question arises as to which actions can be taken to reorganize a company, and much more importantly, which actions can spur the company’s performance and thus satisfy the shareholder and enhance the company’s value effectively.

It therefore is the goal of this paper to provide an overview of empirical studies that might give evidences on how shareholder value responds to different modes of restructuring. Due to the restriction in pages, this study will give an insight in different modes of restructurings but will not go into detail on how corporate restructuring influences the shareholder value for specific regions or industries. Rather, the aim is to present a compact picture of the restructuring results which serve as an “appetizer” for further in depth readings about this topic.

To do so, this paper will approach the subject step by step:

The first part of this paper deals with fundamentals of corporate restructuring. It defines the term “shareholder value” and explains different approaches of how an effect of corporate restructuring can be measured monetarily. Furthermore, the term “corporate restructuring” and the different changes in the firm’s portfolio, organization, or capital structure are described and categorized in an easily memorable model.

The second part of the paper presents different important empirical studies of whether and how restructuring effects shareholder value. The model, described in the first part, is being employed to structure these findings and is being combined with the positive or negative impacts of the conducted method of restructuring.

Lastly, the third part will briefly summarize the introduced effects on shareholder value and will give advice as to which forms of restructuring should be accomplished to enhance the overall economic performance of the firm and therefore the shareholder value.

2 Fundamentals of Corporate Restructuring – Terms and Definitions

Shareholder value and corporate restructuring are “buzzwords” of our modern society. However, what does shareholder value mean and how can one measure a positive or negative deviation of value? What modes of restructuring exist and how can these corporate reorganizations be defined and categorized? This chapter will propose answers to these questions by presenting two ways of how shareholder value creation can be measured. Furthermore, it will present a widely established separation of the different forms of corporate restructuring.

2.1 How to Measure Shareholder Value Creation

The term shareholder value is often used but people seldom question how it can be measured. Literature distinguishes between two measures of shareholder value creation (Bowman, Singh, Useem, Bhadury 1999):

Firstly, shareholder value creation can be measured by examining the abnormal leaps in the company’s stock price in the days and weeks after the restructuring announcement. This abnormal volatility in the firm’s share price is adjusted for market trends and therefore can directly be attributed to the restructuring of the company. Many empirical studies opt for this method of quantifying shareholder value creation by examining pre- and post-restructuring share prices. This method is called capital asset pricing (CAPM). (for further reading on the CAPM model please refer to: Watson & Head 2003, Bühner 1990)

Secondly, and mainly employed when the company’s stock is publicly traded or the company’s performance is to be measured in the long run, the generation of shareholder value can be calculated by analyzing changes in financial measures of the company. These changes can only be identified by comparing the pre- and post-restructuring financial reports. Thus, by analyzing the firm’s net cash flow (which is influenced by increasing revenues and cost reduction), the increase in shareholder value can be quantified (Brickley, Smith, Zimmerman & Willett 2003). This method of measuring the shareholder value is also supported by Hailemariam (2001) and Johnson (2003), who state that shareholder value is created when the return on investment is improved by increasing cash inflows and reducing risks.

2.2 Corporate Restructuring – Definitions and Classifications

Corporate restructuring, when broadly defined, means the change in the operational and financial structures of a company in order to increase its competitiveness and efficiency. (Hoskisson and Turk 1990/Hailemariam 2001). Furthermore, corporate restructuring includes all strategies and actions that corporations take to increase the efficient use of capital and, more importantly, raise the return on investment and, therefore, the value of the company.

To explain the various forms of corporate restructuring, a model of Bowman and Singh (1993) will be employed. The authors identify three distinct types of corporate restructuring: Portfolio, financial and organizational restructuring, which will be examined more closely in the following paragraphs (also see appendix 1 for an overview).

2.2.1 Portfolio Restructuring

Portfolio restructuring involves a reconfiguration of the company’s lines of business through acquisitions and divestures (Bowman & Singh 1990). With divesting or selling a part of a company (e.g. assets, product lines, divisions or brands), the company can adjust to a changing environment, sharpen its business, and raise needed money. Two particular forms of divestment are sell-offs and spin-offs.

Sell-offs involve selling a part of a business to a third party. In return, the divesting company usually receives cash. The most common reason for sell-offs is to divest non-core business units to generate money and therefore ease cash flow problems.

While the ownership structure changes when selling-off a part of a company, there is no change in ownership when spinning-off a company. Spin-off therefore means that a new company is being created by transferring assets from the original company to the newly created one. The owners of the original company now hold shares in these two companies. (Pike & Neale 2003)

Another change in the company’s portfolio can be accomplished by merging with or acquiring a firm. This process is commonly known as merger and acquisition (M&A) or takeover. When a company acquires another company (a target company) whose management is opposed to the arrangement, this action is known as hostile takeover (Alkhafaji 2001, p. 131). If the target firm is in favor for the acquisition, the acquisition is called friendly takeover.

2.2.2 Financial Restructuring

Financial restructuring differs from portfolio restructuring, in that it is not concerned with changing the strategic scope of the enterprise, but rather with altering its capital and ownership structure. One method of financial restructuring, which became increasingly accepted during the 1980s (due to the fact that share repurchase was allowed only for preferred shares) is called share repurchase. A company can repurchase equity via a tender offer, a purchase in the open market or a private purchase.

In a tender offer, the company offers to buy a specified amount of stock at a given price (typically above the market price) until an expiration date (three weeks to one month after the offer). Open market purchases involve a gradual process of buying back small quantities of stock from day to day in the open market through a broker. The firm pays the normal commission rates and the seller of the stock is not aware that he is selling to the corporation. It is not uncommon that repurchase plans take place over several years and the amounts repurchased are generally smaller than via tender offers. The least common method of repurchase occurs via direct or private repurchase. This method entails buying a block of shares from a large holder by direct negotiation. Either the shareholder or the company can take the initiative. (Brealey & Myers 2003, p. 435)

Another mode of financially restructuring a firm is by changing debt in equity. There are two reasons for a company to carry out a debt-for-equity swap: Firstly, when a company is in financial trouble and faces bankruptcy, it can refinance itself by offering its debt holders equity position in exchange for cancellation of the debt. Secondly, a company can take advantage of current stock valuation to change its capital structure. (Reuvid 2002)

The third type of divesting occurs, when the existing company is sold to a third party that finances the purchase price with a substantial amount of straight debt and mezzanine finance by venture capitalists. Later on, the debt is serviced by the cash-generating capacity of the acquired firm.

When the acquiring-group is led by the firm’s management, one speaks of management buy-out (MBO); otherwise, the method is called leveraged buy-out (LBO). In a buyout, usually three parties interact: The directors of the group or company looking to divest, the group that makes the buy-out and the financial backers of the acquiring group. (Brealey & Myers 2003, Pike & Neale 2003, Gilbert 1982)

2.2.3 Organizational Restructuring

The last mode of restructuring is called organizational restructuring. According to Heugens and Schenk (2004, p. 88), organizational restructuring includes significant changes to the structural properties of a firm. It is usually undertaken to substantively or symbolically stress the importance of increasing the company’s efficiency or effectiveness or to align the organization’s structure with its strategy.

Examples of organizational restructurings are streamlining internal processes, reforming governance, redrawing divisional boundaries and flattening hierarchical levels. These modes are often accompanied by the downsizing of companies and layoffs. (Bowman and Singh 1993)

Nevertheless, in most cases, organizational restructuring is only a by-product of the two other restructuring modes because changes in the capital structure or strategic scope of a company have to go with changes in its authority and decision-making hierarchies (Prechel 1994)

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