Session 13 © Furrer 2002-20081 Corporate Strategy Fall 2008 Session 13 Divestures and Restructuring Dr. Olivier Furrer Office: TvA 1-1-11, Phone: 361 30

Session 13 © Furrer 2002-2008 1

Corporate StrategyFall 2008

Session 13

Divestures and Restructuring

Dr. Olivier Furrer

Office: TvA 1-1-11, Phone: 361 30 79e-mail: [email protected]

Office Hours: only by appointment


Need for Restructuring


Number of Divestitures, 1965-2000


Restructuring and Divestment

• Why restructure or divest?– Pull-back from overdiversification.– Attacks by competitors on core

businesses.– Diminished strategic advantages of

vertical integration and diversification.

• Exit strategies– Divestment– spinoffs of profitable SBUs to investors;

management buy outs (MBOs).– Harvest– halting investment, maximizing cash flow.– Liquidation– Cease operations, write off assets.


Reasons for Divestitures

• Change of focus or corporate strategy 43• Unit unprofitable or mistake 22• Sale to finance acquisition or

leveraged restructuring 29• Antitrust 2• Need cash 3• To defend against takeover 1• Good price 3• Total 103

Source: Kaplan and Weisbach, 1992

Reason Nb. of Divestitures


Source: Mergerstat Review, 1994-1998, 2001.

U.S. Mergers and Acquisitionsversus Divestitures, 1965-2000


Strategies in Declining Industries

Company Strengths Relative to Remaining Pockets of Demand

Inte

nsi

ty o

f C

omp

etit

ion

in

Dec

lin

ing

Ind

ust

ry

Few strengths Many strengths

High

Low

DivestQuickly

Nicheor Harvest

Harvestor Divest

Leadershipor Niche

Source: adapted from Porter (1980)

Leadership: Seek a leadership position in terms of market share.Niche: Create or defend a strong position in a particular segment.Harvest: Manage a controlled disinvestment, taking advantage of strengths.Divest Quickly: Liquidate the investment as early in the decline as possible.


Turnaround Strategy

• The causes of corporate decline– Poor management– incompetence, neglect

– Overexpansion– empire-building CEO’s

– Inadequate financial controls– no profit responsibility

– High costs– low labor productivity

– New competition– powerful emerging competitors

– Unforeseen demand shifts– major market changes

– Organizational inertia– slow to respond to new competitive conditions


The Main Steps of Turnaround

• Changing the leadership– Replace entrenched management with new managers.

• Redefining strategic focus– Evaluate and reconstitute the organization’s strategy.

• Asset sales and closures– Divest unwanted assets for investment resources.

• Improving profitability– Reduce costs, tighten finance and performance controls.

• Acquisitions– Make acquisitions of skills and competencies to strengthen core

businesses.


Types of Restructuring

• Portfolio Restructuring– Portfolio restructuring involves significant change in the

firm’s configuration of lines of business through acquisition and divesture transactions.

• Financial Restructuring– MBO and LBO. The assumption is that a large amount of

dept will force managers to focus on their core businesses, and not squander cash flows from the core businesses in less rewarding diversification projects.

• Organizational Restructuring– Traditionally, organizational restructuring has been shown to

be ineffective because it is disruptive and may destroy competencies


Restructuring Managerial Incentives

• Corporate Executives’ Compensation

• To prevent overdiversification

• Divisional Executives’ Compensation

• To attract and retain talents

• To encourage cooperation or competition

• To balance short-term and long-term objectives

• To control risk-taking behaviors


Restructuring Managerial Incentives(Cont’d)

• Headquarters managers of the parent company may want to change the incentive structure to encourage different behaviors among divisions.

• For example, executive in an entrepreneurial division needing growth may receive low salaries and limited short-term earnings incentives but significant “phantom” stock options in order to create more risk taking.

• A division at a later growth stage may emphasize salary and short-term bonus and play down stock options.


Restructuring Managerial Incentives(Managerial Implications)

• Many executive compensation plans provide incentives (perhaps unintended) for corporate managers to diversify their firms and thereby to increase the firms’ size. Thus, corporate incentive compensation should emphasize firm performance over which managers have some control, regardless of firm size or diversity.

• Incentive based on annual ROI may enhance short-term performance but reduce divisional managers risk taking.

• Long-term incentives alone are not adequate. To be most effective, they should be combined with other forms of restructuring, particularly downscoping.

• Long-term incentives also have trade-offs, for example, long-term incentives based on divisional performance may reduce cooperation among related divisions.

• To be meaningful to executives, incentives should be linked to a level and a type of performance that board members can link to managerial action. They should also be based on challenging but achievable targets.

Hoskisson and Hitt, 1994


Downsizing

Risk of lost of human capital


DownsizingWholesale reduction of employees

DownscopingSelectively divesting or closing non-core businesses

Restructuring Activities

Ref.: Hoskisson and Hitt, 1994; Hitt, Hoskissson and Ireland, 2007

Leveraged Buyouts (LBO)Financial restructuring in align managers’ focusand shareholders’ interest


Downsizing

• Downsizing is a reduction in the number of a firm’s employees and, sometimes, in the number of its operating units, but it, may or may not change the composition of businesses in the company’s portfolio.

Thus, downsizing is an intentional proactive management strategy, whereas “decline is an environmental or organizational phenomenon that occurs involuntarily and results in erosion of an organizational resource base” (McKinley, Zhao, and Rust, 2000).

• In 2005, GM signaled that is will lay off 25’000 people through 2008 due to poor competitive performance, especially as a result of the improved performance of foreign competitors (Wall Street Journal, 2005).


Downscoping

• Downscoping refers to divestiture, spin-off, or some other means of eliminating businesses that are unrelated to a firm’s core businesses.

Commonly, downscoping is described as a set of actions that causes a firm to strategically refocus on its core businesses (Danikoff, Koller, and Schneider, 2002).

• In 2005, Sara Lee Corporation has decided to spin off its apparel business in a “massive restructuring that will shed operations with annual revenues of $8.2 bio.” It will try “to focus on its strongest brands in bakery, meat and household products.” The restructuring will trim revenues that used to account for 40% of sales. The company plans to use some of the savings to R&D new products in its top selling brands (Wall Street Journal, 2005).


Leveraged Buyouts

• Purchase involving mostly borrowed funds

• Generally occurs in mature industries where R&D and innovation are not central to value creation

• High debt load commits cash-flows to repay debt, creating strong discipline for management

• Increases concentration of ownership

• Focuses attention of management on shareholder value

• Greater oversight by “active investor” board members

• Leads to more value-based decision making


Restructuring and Outcomes

Downsizing

Downscoping

LeveragedBuyout

Reduced Labor Costs

Reduced Debt Costs

High Debt Costs

Loss of Human Capital

Lower Performance

Higher Performance

Higher Risk

Alternatives Short-Term Outcomes

Long-Term Outcomes

Emphasis on Strategic Controls

Documents

Session 13 © Furrer 2002-20081 Corporate Strategy Fall 2008 Session 13 Divestures and Restructuring Dr. Olivier Furrer Office: TvA 1-1-11, Phone: 361 30