A Resource Based Interpretation of Performance Enhancing Capital Structure Changes: The O.M. Scott LBO Revisited

28 Pages Posted: 10 Nov 2010

Date Written: September 7, 2004

Abstract

The O.M. Scott case study published in 1989 in the Journal of Financial Economics has come to be a classic in illustrating the plausibility of some fundamental concepts that underpin mainstream models of the efficiency attributes of capital structure in modern corporate finance. In these models, high leverage traditionally appears as a strong incentive to refrain from sub-optimal investment behavior by self-interested managers. Thus reducing managerial agency cost has been considered as an essential driver of enhanced value in much of financial modeling. In the present paper, we attempt a somewhat different, albeit complementary, mainly resource based interpretation of the very rich empirical material contained in Baker and Wruck (1989). In fact, a close reading of the case suggests that the observed significant increase in operating performance post-LBO was to a great extent the consequence of the yet unexplored cognitive changes implied by switching dominant shareholders. Namely, we find that value at O.M. Scott was essentially increased by (1) a significant reduction in what may be termed cognitive agency costs while (2) the new dominant shareholder contributed substantial cognitive value by stimulating and advising a dynamic learning process leading to enforced managerial capabilities, especially with respect to more effective routines of cash management.

Suggested Citation

Wirtz, Peter, A Resource Based Interpretation of Performance Enhancing Capital Structure Changes: The O.M. Scott LBO Revisited (September 7, 2004). Available at SSRN: https://ssrn.com/abstract=1705591 or http://dx.doi.org/10.2139/ssrn.1705591

Peter Wirtz (Contact Author)

University of Lyon 3 ( email )

1 rue de Université
B.P. 0638
Lyon, 69007
France

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