The Restructuring Environment

Motives and Methods

Methods and Motives: Stewart and Glassman

Main Motives for Restructuring– Strengthen incentives– Better business fit– Sharpen management focus– Create pure plays with unique investment appeal– Roll back unproductive investments– Stop subsidizing un-profitable divisions– Higher value use of assets– Increased debt capacity– Reduced taxes

Categories of Restructuring

Asset restructuring: Change ownership status of assets

Business unit restructuring: acquisitions, joint ventures, carve-outs, spin-offs

Corporate Restructuring: change in ownership structure of a parent such as new security offers, share repurchases, leveraged ESOP, leveraged cash outs, sale or liquidation

Importance of Debt

Debt is cheaper than equity Concentration of equity ownership reduces

agency costs (How?) Debt adds discipline (How and Why?)

Reasons for Aggressive Debt Use

Cash disgorgement: (i.e., discipline)– SOHIO: Why high ROE and MV/BV but not P/E?– Ross Johnson of RJR Nabisco: will people spend

money carelessly?– Agency problems

To what degree is the market more "astute than the corporate manager?

– To what degree do we rely on internal or external control? (see pg. 588)

– Does technical sophistication lead to business sophistication?

Methods: Returning Control of Cash to the Market

Repurchase shares– Exxon and overcapacity

Leveraged Recapitalization– Does the corporation get better terms if it restructures

on its own? (i.e., Compare Gulf to Exxon) Partnerships

– Mesa Petroleum: replaced R&D with interest payments

Returning Control of Cash to the Market

Leveraged Acquisitions– SOCAL "white knight" takeover of Gulf

Payout dividends– Is this a good idea?

Carve-outs– A partial public offering– Easier to value an "unbundled" set of units

Restructuring to Align Incentives with Shareholder Interests

See Stewart table on page 593 What happens as we move from left to right? How do incentives change with the form of

compensation? What is the allocation of risk and return?

The Leveraged Cash Out

Nature of the Transaction– All existing shares replaced with cash and new shares

(not a buyout): cash raised with debt– Shareholders compensated for existing value– Employees and management given new incentive

package: residual compensation structure ("thrift plan" for employees, ownsership paln for management

Impact on Agency Costs Impact on Wealth and Risk allocation

External and Voluntary Restructuring

External: restructuring imposed on management by outside pressure from equity investors

Voluntary: restructuring initiated internally in respose to the need to do so.

Role of the "Social Environment" in the 1950's - 1970's

Mature markets:growth slows to industry average

Tax policies favorretention andreinvestment

Internal capitalmarket response:

Diversify

Concentratedcapital

Lack of External Capital Market Opposition in the 1950's - 70's

Passive investors

Founder interest

Flawed analysis

Inertia

How does the case of Armco Steel Illustrate Inertia?Was Armco going around in circles?

Imperatives for Change: Voluntary Restructuring

Four Pre-conditions (necessary but not sufficient– Evidence of flawed strategy or structure– Shift in power balance to favor disadvantaged

constituencies– Availability of alternative options– Leadership

Importance of Leadership

Restructuring requires a champion: one person usually leads the charge

– Importance of concentration and focus Why did so many internal restructuring efforts

fail in the 80's?– Emphasis on TQM: participation– Japanese management: consensus– Competing constituencies

Burlington Northern Case

What does the Burlington Northern case teach about the importance of leadership?

Trigger Events: Sufficiency

Common Trigger Events:– Sudden and visible deterioration (Armco)– Change in CEO (Burlington Northern)– Internal intervention by strong personality (Household

International, Burlington Northern)

Safeway: Internal and External Restructuring

What is the story of Safeway? What is the "trigger event," and what is its critical

role?

Redistributive Effects of Restructuring: Initial Inquiry

What have the redistributive effects of restructuring been to date?

– Impact on investors Broad perspective: "The market" Narrow perspective: Institutions and Individuals

– Impact on employees– Impact on Management

What role have "agency costs" played?