Causes and Effects of Corporate Refocusing Programs
Philip G. Berger
University of Chicago - Booth School of Business
New York University (NYU) - Department of Finance
Despite the weakening disciplinary role of the takeover market, there has been a rash of divestiture and split-up announcements recently by such prominent firms as AT&T, ITT, W.R. Grace, and many others. In this paper we examine refocusing decisions by diversified firms that have not been taken over, with the goal of closing some of the gaps in our understanding of the workings of different sources of management discipline. We study the effect on refocusing likelihood of four factors: The diversification program's impact on shareholder value; the characteristics of the diversification program; events of market discipline such as management turnover, outside shareholder pressure, and financial distress; and corporate governance variables such as CEO option holdings, CEO tenure, and board independence. In contrast to the lessons learned from studying reorganizations that follow takeovers, which are extreme events in the life of a corporation, the insights from this study are more representative of the broader set of factors that lead to divisive reorganizations.We find that concerns about shareholder value do affect refocusing decisions, with diversified firms that refocus having significantly greater value losses from their diversification policies than multisegment firms that do not refocus. Several characteristics of diversification that have been argued to contribute to, or reduce, the value- reduction from pursuing a diversification strategy are found to have separable effects on the likelihood of refocusing. More relatedness among the firm's business lines reduces the chance of restructuring, whereas greater cross-subsidies from profitable to unprofitable lines and higher levels of central overhead expenses increases the probability of divestitures. Despite the importance of shareholder value considerations, major events of market discipline usually must occur before managers attempt to undo value-reducing diversification programs, whereas the same events occur only rarely for a matched sample of nonrefocusing firms during the same time frame. A significant minority of refocusing firms make their divestitures without the prodding of events of market discipline, and without facing unusually high probabilities that such events are about to occur. The internal incentive mechanism inducing CEOs to restructure voluntarily is CEO option ownership, implying that providing CEOs with forms of performance-based incentive compensation that increase risk tolerance can help to reverse suboptimal diversification policies. Finally, consistent with divestitures reversing, at least in part, value destruction from unsuccessful diversification strategies, the cumulative abnormal returns over a firm's refocusing-related announcements average 7.3%, and are significantly related to the amount of value that was being destroyed by the refocuser's diversification policy.
JEL Classification: G31, G32, G34
Date posted: May 5, 1997