Restructuring scope, performance and R&D intensity: do all restructuring activities create value?(1)

ABSTRACT

One of the most prominent aspects of corporate behavior during the 1980s was corporate restructuring--changes of business portfolios through a high level of acquisitions and divestitures. However, little attention has focused on the consequences of restructuring activities. This paper investigated the impact of corporate restructuring activities on a firm's financial performance and long-term competitiveness during 1980s. In comparing a sample of nonrestructured firms, this study found that there are no significant performance differences between restructured and nonrestructured firms and the impacts of corporate restructuring vary depending on restructuring scope. Additionally, there exists a partial substitution relationship between restructuring scope and R&D intensity.

INTRODUCTION

The corporate restructuring phenomenon marked a drastic difference from the predominantly acquisitive period in the 1960s & 1970s (Singh 1993). On the one hand, a growing number of companies that once thought diversification and expansion were vital, are abruptly changing course. Many conglomerates have restructured their diversified businesses through divestitures and acquisitions. They are slimming down and narrowing their focus, lopping off divisions, and selling assets and product lines. They are not only jettisoning bad acquisitions of the early 1970s, but also making moves to spin off and scale down healthy businesses to concentrate on what they do best. Overall they reduce their degree of diversification. For example, Porter (1987) reported that half of the unrelated acquisitions made by conglomerates during the 1960s and 1970s have been reversed through divestitures. Similarly, Ravenscraft and Scherer (1987) estimated one-third of all (including related) acquisitions made in the 1960s and 1970s were later divested. Ollinger's (1994) research of the oil industry indicates that by 1990 many oil companies (e.g., EXXON, AMOCO, Mobil) had sold most of their unrelated businesses. Discarding all of their completely unrelated businesses such as retailing, electronics and electric motors, oil companies retained some units that were natural extensions of, or only distantly related to their existing businesses, such as mining.

On the other hand, the corporate refocusing movement does not mean that all diversified firms have terminated their diversification strategy all together. In fact, some researchers have observed that a significant number of firms are still diversifying their businesses, which defies the gospel of 1980s: focus on a few core businesses. Continuous expansion is still a popular measure of success in growth-oriented Corporate America. Many substantially diversified firms--Westinghouse, Berkshire Hathaway, Philip Morris, Hanson Trust, Teledyne, 3M etc. seem not to have followed the bandwagon of "downscoping." Statistics and empirical studies also indicate that the trend of diversifying continues, despite the business rhetoric of refocusing on firms' core businesses. For example, Davies, Diekmann and Tinsley (1994) found that 30 percent of largest firms still operated in three or more 2-digit industries in 1990 and shown sign of reversion. Markides' (1994) empirical study of Fortune 500 companies suggested that there exists an optimal level of diversification. From a random sample of the diversified firms, some might have over-diversified (above the optimal level), while others might be below their optimal diversification levels. Assuming profit-maximizing behavior of these firms, he found that the "under-diversified" firms would increase the degree of their business diversity, while the "over-diversified" firms would decrease the degree of their business diversity. He further found that the aggregate diversification level has not changed in the 1980s, which he attributed to the above-mentioned counterbalance movements of refocusing and diversifying. In a similar vein, Hoskisson and Johnson's (1992) empirical study also suggested that the widely diversified firms were not the prime target for corporate restructuring and restructuring may not always result in a reduction in the degree of business diversity. In fact, they found that due to inconsistent control systems (i.e., financial control vs strategic control), more firms were moving away from the intermediate strategy (i.e., related-linked) type and becoming distinctively related (reduction in diversification) or unrelated firms (increase in diversification). Although, to some extent, their conclusions are contradictory to Markides' (I 994) finding of optimal diversification levels, both studies suggested the juxtaposed diversifying and refocusing activities in the 1980s in Corporate America.

The swath of corporate restructuring activities poses questions to strategy researchers: why have firms changed their business portfolio so radically within such a short period of time? What are the consequences of firms' restructuring activities. Do restructuring activities always create value? Are there significant performance differences between restructured firms and non-restructured firms? Are certain types of restructuring activities associated with high levels of corporate performance? Are other types of restructuring strategies associated with lower levels of corporate performance? Despite wide attention from disciplines such as financial economics, business policy and strategy, and organization management, surprisingly little effort has been directed to examine these questions.

This paper is organized as follows. Attention is first devoted to a review of current literature on corporate restructuring. It is followed by hypothesis development regarding the influence of corporate restructuring activities on accounting performance and long-term competitiveness. Research design, data analysis and results are discussed next. Finally, this paper concludes with contributions and future research directions.

THEORETICAL BACKGROUND

Literature review suggests that: 1) corporate restructuring activities have been attributed to both macro, environmental, and micro, organizational factors; 2) scant research has been devoted to investigating the consequences of corporate restructuring. Among the few studies, their findings remain controversial and inconsistent.

Antecedents of Corporate Restructuring

Macro, Environmental Explanations. Environmental explanations contend that recent restructuring activities fit into a broad pattern of historical episodes, and are a function of organizational adaptation to major changes in the regulatory and competitive environments (Bhide, 1990; Bowman & Singh, 1990; Shleifer & Vishny, 1990; Bethel & Liebeskind, 1993). First, the relaxed enforcement of the Cellar-Kefauver Act makes it easier for firms to grow through acquisitions in their own basic industry with less fear of governmental challenge. Because horizontal expansion allows firms to exploit core capabilities better than diversifying expansion, firms may have shed diversified businesses and focused corporate resources on horizontal expansion when the opportunity arises (Shleifer & Vishny, 1990). Second, increasing global competition, deregulation of several key industries in the United States (Weston & Chung, 1990), turbulence due to technological innovations and demand change (Quinn, Doorley & Paquette, 1990) have ushered in an era of intensive rivalry (D'Aveni & Illinitch, 1992). Firms may have to reexamine their business concepts and reconsider capabilities and restructure their business portfolio in order to survive (Bowman & Singh, 1990). Third, in financial economic circles, many view corporate restructuring as transactions in a market for corporate control, where alternative management teams compete for the right to control the undervalued assets (Jensen, 1986). It is a mechanism that disciplines management teams that fail to realize a firm's potential value, and prompts managers to initiate defensive measures in order to thwart such bids through restructuring. The notion that the external capital market harmonizes agency conflicts through the threat of transfer of corporate control was suggested by Manne (1965) and refined by Fama (1980) and Fama and Jensen (1983a; 1983b). In this view, firms that are poorly managed and unprofitable become takeover targets. Outsiders attempt to displace incumbent managers in order to shift strategy, make efficient use of financial slack, and reap the gains stemming from increased profitability. These threats of displacement may help to discipline management by compelling it to expend more effort in pursuit of shareholder wealth maximization. Failure to improve firm performance, whether due to excessive consumption of corporate perquisites or due to low managerial abilities may ultimately lead to a transfer of corporate control.

While the environmental explanations focus on the issue of why corporate restructuring happened in 1980s, rather than in 1960s or 1970s where conglomerate diversification became dominant (Bethel & Liebeskind, 1993), the micro level research mainly deals with the issue of why some firms restructured and others did not in the 1980s, given the same operating environments.

Micro level, Organizational Explanations. A widely used framework to the analysis of corporate behavior has been agency theory, or the idea that managers pursue their own objectives that need not serve the interest of shareholders. Jensen (1986) and other agency theorists interpreted the restructuring wave in the 1980s mainly as an attempt to control nonvalue maximizing behavior of corporate managers and correct for inefficient over-expansion and over-diversification during 1960s and 1970s, when managers increased the size and scope of firms without increasing their value (Jenson, 1986, 1991). One of the factors noted by agency theorists has been the changes in the firms' governance structure during the 1980s, which constrained managers' opportunistic behavior and pressured them to divest or sell offthese diversified businesses. For example, it has been observed that the proportion of shares of large public U.S. corporations managed by institutions rose dramatically during the late 1970s and 1980s. Chaganti and Damapour (1991) reported that the …