Introduction
According to Gilson (2001), corporate restructuring is what happens when a corporate entity revises in a major way, the various contracts that radically exist between it and all its stakeholders who include its employees, creditors and shareholders.
There are various reasons for restructuring that I shall look at later but the result of restructuring is that it substantially alters the company’s organizational structure, shareholding and market value (Wruck 1994). In many corporations, restructuring is a major decision that requires approval from the highest levels of authority in the company. Restructuring more often than not brings about a huge value gap between the restructured and the pre-restructured entity (Jensen 1993).
Before an organization can restructure, it must make several preliminary steps which mostly have to do with seeing various consents from relevant parties and also sorting out possibly controversial issues such as the laying off of employees or the sale of shares (Mitchell & Mulherin 1996).
In addition, the company needs to consider the three hurdles that are associated with restructuring (Gilson 1997). These are; design, execution and marketing. The issue of design looks at the type of restructuring, its appropriateness and its efficiency in eliminating the causative agent for the restructuring.
Execution of the restructuring plan is probably the most critical part of corporate restructuring. The company must anticipate the challenges that are likely to occur during the implementation and make provisions for them in a satisfactory manner. The plan should be designed in a manner that execution is achieved in a way that minimum barriers are encountered but value is maximized.
The last part to be considered is marketing the new entity formed. The design plan of the restructuring must include this part since markets are usually keen on the change in value and character in the restructured company. This is because there is no guarantee that the restructuring programme will yield increased value (Gordon 1994).
Causes of restructuring
Gilson (2001) states that there are various reasons why companies feel a need to restructure. The first reason is definitely to curb poor financial performance. Gilson states that the warning signs for a poorly performing company are very clear. These come in the form of stagnant sales, accounting losses, loss of customer base and failures in stock prices.
Often, poor financial performance leads the company to default in its debts which may lead to bankruptcy. While debt restructuring can be costly and strenuous for the company there are some legal alternatives available to the company such as filing for bankruptcy which give the company a clean break.
However, the legal approach might leave the company’s image dented hence the preference for arranged restructured processes. “The other reason for restructuring is to accommodate a new corporate strategy or to strategically place the company in a position to take advantage of an available business opportunity” (Gilson 2001).
A good example of such restructuring is an equity spin-off. In spin offs a company that had previously diversified its businesses splits these diversified businesses into autonomous entities each with their own separate stock. They make economic sense where the reason for poor performance of these diversified businesses is the bureaucracy of the parent company. The company decides to list these different entities if their different values are higher when valued separately than when they are listed singularly.
The third reason for restructuring is to make capital value corrections that are erroneous in nature and which do not reflect an accurate picture of the company’s real market value. Just like in spin-offs, the problem that needs restructuring to correct value affects diversified businesses.
Here the company may become a victim of poor judgement by financial analysts or lack of technical expertise to analyze and assess the various business operations in a company and compound their value. Reducing the value gap needs innovative ways of restructuring such as the now popular leverage buyouts, stock market buybacks and the practice of tracking stock.
When it comes to restructuring, Gilson (2001) states that companies should avoid waiting for the worst to strike. This is because the consequences of such waiting may be too severe for the company to efficiently deal with them. Again, management during crisis is difficult since there is no time for the managers to sit and analyze the magnitude and possible effects of the crisis thus decisions are made based on fear and panic rather than informed choices (Dennis et al.1997).
Gilson gives an example of a company that needs to lay off a significant percentage of its employees so as to be competitive. He suggests that such a company would rather begin a gradual reduction of the workplace rather than lay off the employees at once affecting motivation and the external perception of the company. He recommends that companies take an annual restructuring audit to identify the areas that need to be changed before a crisis looms.
A corporate example of restructuring
Scott Paper Company is cited by Gilson (2001) as probably one of the best examples of a company that underwent a successful restructuring program. From the time the merger between Scott Paper and Kimberly-Clark Ltd was announced on July 17, 1995. Before the merger, Scott’s performance had been lacklustre and they were losing much of their business to competitors.
Additionally, companies such as Weyerhaeuser and James River had successfully undertaken similar restructuring programmes. Perhaps the success of Scott Paper’s restructuring can be attributed to the hard work and commitment of its C.E.O and Chairman, Al Dunlap. During Dunlap’s tenure as C.E.O he had increased the company’s market value by $6.5 billion. However, the restructuring was long overdue and its timing was perfect.
At the time of the merger, Kimberly-Clark’s share price was about $60 but by August 29, 1997 after the merger had been completed, the value had risen to $110. Dunlap (1996) noted that “Kimberly-Clark continues to benefit from its merger with Scott Paper, which has fuelled improved earnings…” Not only had the merger revitalized Scott Paper but it had also diversified its businesses. In its 1994 report, Dunlap stated that “The new Scott–we’re not just a paper company anymore.”
Upon completion of the merger, Scott and Kimberly-Clark became the second largest personal care products producer in the US only second to Procter & Gamble. The entire cost of the merger was $ 7 billion and Scott shareholders were left with a 42% stake in the new entity compared to Kimberly-Clark’s 58%. Though generally successful, the restructuring came at a cost to Scott. It had to lay off almost 11,000 employees in one year and also shed unprofitable divisions such as Scott Health Care and S.D. Warren.
Dunlap (1996) has himself analyzed the entire process and stated the challenges and successes that the management encountered. He states that the shareholders and corporate level managers of both companies emerged as the winners. This is in addition to all parties that invested in the merger.
In addition, the company witnessed a complete turnaround compared to previous years e.g. 1993 when it lost $ 277 million. The company was also heavy into debt with a total figure of over $ 2.5 billion being owed to creditors. On top of that, the company’s stock price was in a state of constant decline (Ferguson 1995).
Lessons from Scott Paper’s Restructuring
Dunlap (1996) having overseen the entire restructuring process analysed the outcomes and formulated four rules for a successful restructuring which can guide any company intending to undertake such a massive restructuring. These four rules are;
First, the company has to come up with the right management team to oversee the restructuring process. Dunlap insists that these executives have to have a proven track record of performance and efficiency for them to be assets to the company.
In Scott Paper, all poorly performing executives, who accounted for over 70 percent of the top management, were among the first employees to be fired in the first year. A new management team with proven track records was brought in which included fourteen of the most experienced marketing directors from Coca Cola, Kimberly-Clark, Colgate-Palmolive and Procter & Gamble. Dunlap then selected a smaller team of trusted executives all with different competences to form part of his inner circle.
The second rule according to Dunlap is cost cutting. In Scott Paper, the payroll reduced by 35 percent through the laying off of 11,200 employees. The next cost cutting came by consolidating procurement on a worldwide level and outsourcing. Goods earlier stocked in record were downsized to 2,000 initially from 11,000.
The company also got rid of executive perks such as luxury cars, jets and beach houses. The company went an extra mile by selling its opulent corporate headquarters and renting alternative space. Dunlap states that these steps though difficult to implement, gave the company a significant competitive advantage over its rivals.
The third strategy is to focus solely on the company’s core business. This is why Scott offloaded its divisions such as health care, power production and food services that diversified the company’s businesses. In addition, the company sold $2 billion of its noncore assets in the first year and also chose to focus on purely high growth products still within the core business by offloading its coated paper business for $1.6 billion (Dial and Murphy 1995).
The fourth and last strategy involves coming up with a strategic plan. In its strategy, Scott changed its product line. It got rid of 31 percent of its previously offered products after it was established that almost half of all of Scott’s products produced a paltry 5 percent of total revenue.
This strategy of testing products contribution by comparing their output to the total revenue caused over 500 products to be removed from production together with 60 domestic products. The rest of the products performed much better in terms of sales output and operating margins.
In addition to getting rid of products, Scott also had a good marketing strategy which was designed around a unified product line. This strategy was designed to save advertising costs while promoting the company’s products on the global stage. Finally, the company had a strategy that involved basing executive pay on shareholder value.
Dunlap states that he invested almost all his personal wealth including additional borrowings which led to ten of Scott’s executives holding over $10 million of the company’s stock (Ferguson 1995). Using this strategy of tying stock option rewards to performance, Scott ensured that its workers remained motivated and committed to the company.
Results of Scott Paper’s restructuring
Scott and Kimberly-Clark found that their merger led to a huge growth in the capital value of the company. It addition, it caused a major shake-up in the industry since the merged company was now America’s second largest personal products company. The major also rejuvenated the stock exchange and in three years, the company’s share price had doubled. Most importantly, the company returned to profitability (Ferguson 1995).
Conclusion
The thorough restructuring of Scott Paper is a good example of how corporate restructuring can transform market and financial performance of the corporate entity. Using the measures described, a company seeking to go Scott’s way can realize a complete turn-around.
References
Dennis, D., Diane, D., and Sarin, A. (1997) Agency Problems, Equity Ownership, and Corporate Diversification, Journal of Finance, 52, 135-160
Dial, J. and Murphy, K. (1995) Incentives, Downsizing, and Value Creation at General Dynamics, Journal of Financial Economics, 37, 261-314
Dunlap, A.J. (1996) Mean Business. New York: Times Books
Ferguson, K. H. (2011) Lessons learned from Scott Paper. Web.
Gilson, S. (1997) Transactions Costs and Capital Structure Choice: Evidence from Financially Distressed Firms, Journal of Finance, 52, 161-196.
Gilson, S. (2001) Creating Value through Corporate Restructuring: Case Studies in Bankruptcies, Buyouts, and Breakups. New York: John Wiley & Sons
Gordon, D. (1994) Corporate Restructuring: Managing the Change Process from Within. Boston: Harvard Business School Press
Jensen, M. (1993) The Modern Industrial Revolution and the Challenge to Internal Control Systems, Journal of Finance, 48, 831-880
Mitchell, M.L., and Mulherin, H.J. (1996) The Impact of Industry Shocks on Takeover and Restructuring Activity, Journal of Financial Economics, 41, 193-229.
Wruck, K. (1994) Financial Policy, Internal Control, and Performance: Sealed Air Corporation’s Leveraged Special Dividend, Journal of Financial Economics 36, 157-192