Chapter 1 Introduction 1.1 Corporate Restructuring Meaning: “To give a new structure, to rebuild or rearrange” Restructuring is corporate management term for the take action of incompletely dismantling or else reorganizing a company for the purpose of making its well-organized and consequently more profitable. It usually involves selling off portions of the business and making severs staff reductions. One of the mainly high profile features of the company and investment worlds is corporate restructuring. Corporate restructuring means actions taken to develop or agreement a firm's basic operations or essentially change its asset or financial structure. Corporate restructuring refers to a wide range of actions that increase or agreement a firm’s operations or considerably change its financial structure or take about a major change in its organizational structure and internal operation. Corporate restructuring is the procedure of redesigning one or more feature of a company. The procedure of reorganizing a company may be implemented due to amount of different factors, such as positioning the business to be more aggressive, stay alive a currently unfavorable economic climate, or bearing the corporation to move in an completely new direction. Now are some examples of why corporate restructuring may take position and what it can represent for the company. Restructuring a corporate body is often a requirement when the business has grown to the point that the original structure can no longer competently manage the production and common interests of the company. For example, a corporate restructuring may call for spinning-off some departments into subsidiaries as a means of creating a more successful management representation as well as taking advantage of tax breaks that would agree to the corporation to divert more returns to the production process. In this situation, the restructuring is seen as a positive symbol of growth of the company and is often welcome by those who wish to see the company gain a larger market share.
1.2 Need for corporate restructuring Corporate restructuring may also get place as a result of the acquisition of the business by new owners. The acquisition may be in the type of a leveraged buyouts, a hostile takeover, or a merger of some form that keeps the business whole as a subsidiary of the controlling company. When the restructuring is due to a hostile takeover, corporate raider often apply a dismantling of the company, selling-off properties and other assets in order to make a profit from the buyout. What remains following this restructuring may be a minor entity that can carry on functioning, although not at the level possible before the takeover took position.
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In general, the plan of corporate restructuring is to allow the business to carry on operation in some manner. Even when corporate raiders divide the business and leave behind a shell of the original structure, there is still regularly a hope, what remains can function well sufficient for a new buyer to purchase the diminished company and return it to profitability.
1.3 Purpose: •
To improve the share holder value, The corporation should continuously assess its: 1. Portfolio of businesses, 2. Capital mix, 3. Ownership & 4. Asset arrangements to find opportunity to increase the share holder’s value.
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To focus on asset use and profitable investment opportunities.
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To reorganize or divest less profitable or loss making business/products.
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The corporation can also improve value through capital Restructuring, it can innovate securities that help to reduce cost of capital.
1.4 Characteristic of corporate restructuring •
To develop the company’s Balance sheet, (by selling unprofitable division
from its core business). business). •
To attain staff reduction ( by selling/closing of o f unprofitable portion)
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Changes in corporate management.
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Outsourcing of function such as payroll and technical support to a more efficient third party.
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Moving of procedures such as manufacturing to lower-cost locations.
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Reorganizing of functions such as sales, marketing and distribution
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Renegotiation of labor contracts to reduce overhead
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Refinancing of corporate debt to decrease interest payments.
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A major public relationships campaign to reposition the company with consumers. 2
1.5 Category of corporate restructuring Corporate restructuring involve a forms of activities including finan cial restructuring, organization restructuring; portfolio restructuring. Figure 1
Category of corporate Restructuring
Financial Restructuring
Organizational Restructuring
Portfolio Restructuring
1.5.1 Financial restructuring Financial restructuring is the restructuring of the financial assets and liabilities of a business in order to make the most beneficial financial environment for the corporation. The process of financial restructuring is often related with corporate restructuring, in that restructuring the general function and work of the business is likely to impact the financial health of the company. When completed, this reorganizes of corporate assets and liabilities can help the company to remain competitive, even in a low economy. Just about every business goes throughout a stage of financial restructuring at one time or another. In some cases, the procedure of restructuring takes place as a means of allocating resources for a new marketing movement or the launch of a new product line. When this happen, the restructuring is often viewed as a sign that the business is financially stable and has set goals for future growth and development. .
1.5.2 Organizational restructuring In organizational restructuring, the center of attention is on management and internal corporate structures. Organizational restructuring has become a very general practice between the firms in order to match the growing competition of the market. This makes
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the company to change the organizational structure of the company for the improvement of the business.
1.5.3 Portfolio restructuring Portfolio restructuring refers to change in the portfolio of business of the corporation. If a company is reshuffle its assets by selling a few of its existing production services or acquiring some new facilities to produce the feeding raw martial for the main product it is called portfolio restructuring. It involves changes in the design of business in which a company is operation throughout acquisitions. It is for creation additional to or disposals from corporations business through acquisitions or spin-offs. Portfolio restructuring also has a high possibility of improving performance although the performance gain is likely to be much more diffident than with financial restructuring. It refers to changes in the sets of companies comprising the corporation to create a more effective configuration of businesses. Effectiveness is increased by combining lines of businesses in areas where the firm has competitive advantage, and by shedding lines of business where it cannot obtain higher returns than its competitors.
Corporate Restructuring Activities Figure 2 Expansion Mergers & acquisition Tender offers Joint venture
SELL-OFFs Spin-off S lit-off
Corporate Restructuring Activities
Corporate control Premium buy-back Standstill Agreements Anti-take over Proxy contests
A
Change in ownership
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Exchange offer
1.6 Methods of corporate restructuring 1. Joint ventures 2. Sell off and spin off 3. Divestitures 4. Equity carve out 5. Share repurchase 6. Leveraged buy outs 7. Management buy outs 8. Master limited partnerships 9. Employee stock ownership plans
1.6.1 Joint Venture Joint ventures is a business enterprise for profit, in which two or more parties share responsibilities in an agreed manner, by providing risk capital technology patent trademark brand name to access to market. Joint ventures with multinational companies give to the development of production capacity; transfer of technology and capital and over all penetrating into global market. Entering into joint ventures is a part of strategic business policy to diversify and enter into new markets, acquire finance, technology, patent and brand names.
1.6.2 Spin-offs Spin-offs are a method to get rid of underperforming or non-core company divisions that can draw down profits. The common definition of spin-offs is when a division of a business or organization becomes an independent business. The "spin-out" business takes assets, intellectual property, technology, and/or existing products from the parent company. Some times the management team of the new company is from the same parent company. A spin-out present the chance for a division to be backed by the company but not be affected by the parent company's image or background, giving potential to take previous ideas that had been languishing in an old environment and help them grow in a new environment.
1.6.3 Spilt off and spilt up Spilt off is a transaction in which some, but not all, parent company shareholders receive shares in a subsidiary, in return for relinquishing their parent company’s share. In other words a number of parent company shareholders receive the subsidiary shares in come back for which they must give up their parent company shares.
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1.6.4 Split up Spilt up is a transaction in which a corporation spin-offs all of its subsidiaries to its shareholders & ceases to exist. -The whole firm is broken up in a series of spin-offs. -The parent firm no longer exists and -Only the new offspring survive. In a split-up, a corporation is split up into two or more independent companies. As a follow-up, the parent company disappears as a corporate body and in its place two or more separate companies emerge.
1.6.5 Sell-off In a strategic planning process, which a company can take decision to concentrate on core business activities by selling off the non core business divisions. A sell-off is a sale of part of the organization to a third party in the following circumstances. To come out of shortage of cash a severs liquidity problems. To concentrate on core business activities. To protect the firm from takeover activities by b y selling off the desirable division to the bidder. To improve the profitability of the firm by selling off loss making divisions. To increase the efficiency of men, machines and money. • • •
• •
1.6.6 Divestments Divesture is a deal through which a company sells a section of its assets or a division to another company. It involves selling some of the assets or separation for cash or securities to a third party which is an outsider. Divestiture is a form of reduction for the selling company. means of expansion for the purchasing company. It represents the sale of a section of a business (assets, a product line, a subsidiary) to a third party for cash and or securities.
1.6.7 Equity carve outs A agreement in which a parent company offers some of a subsidiaries common stock to the general public, to bring in a cash combination to the parent without loss of control. In other words equity carve outs are those in which a number of of a subsidiaries shares are offered for a sale to the general public, bringing an combination of cash to the parent firm without loss of control. Equity carve out is also a way of reducing their contact to a riskier line of business and to increase shareholders value.
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1.6.8 Share repurchases A program through a company buys back its own shares from the marketplace, reducing the number of outstanding shares. This is usually a sign that the company's management thinks the shares are undervalued. Because a share repurchase reduces the amount of shares outstanding, it increases earnings per share and tends to raise the market value of the remaining shares. When a corporation does repurchase shares, it will generally say something along the lines of, "We find no better investment than our own corporation. In adding to above methods of restructuring, Buy-back is also used as restructuring strategy so as to increase earning per share of the corporation. Policy used to increase market price of share is called as Subdivision of shares, which is also type of corporate restructuring.
1.6.9 Leveraged Buy outs A leveraged buy outs is any acquisition of a company which leaves the acquired operating entity with a greater then traditional debt to equity ratio. The consideration for leveraged buy outs is a mix of debt and equity components with high gearing. Strong cash flows and high returns are used to serve the high levels of interest and repayments of principal internal cash flow and sales of assets are used to repay the original owner in leveraged buy outs. In a leveraged buyout, the corporation is purchased primarily with borrowed funds. In fact, as a lot of 90% of the purchase price can be borrowed. This can be a risky decision, as the assets of the business are regularly used as collateral, and if the business fails to perform, it can go bankrupt for the reason that the people concerned in the buyout will not be able to service their debt.
1.6.10 Management buy outs In this case, management of the corporation buys the business, and they may be joined by employees in the venture. This practice is from time to time questioned because management can have inequitable advantages in negotiations, and could potentially influence the value of the business in order to carry down the purchase price for them. On the other hand, for employees and management, the opportunity of being able to buy out their employers in the future may serve as an incentive to make the business physically powerful. Management buy outs occurs when a company's managers buy or acquire a large part of the corporation. The goal of a management buy outs may be to make stronger the managers' interest in the success of the company.
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1.6.11 Master limited partnership Master Limited Partnership is a type of limited partnership in which the shares are publicly traded. The limited partnership benefits are divided into units which are traded as shares of common stock. Shares of rights are referred to as units.
1.6.12 Employee’s stock option plan An Employee Stock Option is a type of define contribution benefit plan that buys and holds stock. Employ stock option plan is a qualified, defined contribution, employee benefit plan designed to invest primarily in the stock of the sponsoring employer. Employee Stock Options are qualified in the sense that the employ stock option plan sponsoring company, the selling shareholder and participants receive various tax benefits. In employ stock option plan employees never buy or hold the stock directly.
1.7 Research objectives My research objective is that to find out the circumstances in which the company adopted the process of corporate restructuring. I identified the all process of corporate restructuring used in organizations. I discussed some of method are used by the companies adopted corporate restructuring. My objective of research to define why companies are needs of corporate restructuring? To identify the corporate restructuring are provide better effect to companies? In the direction of define the structure of corporate restructuring. My thesis work focus lying on corporate restructuring and a number of of methods of corporate restructuring.
1.8 Research Process My research topic is corporate restructuring and its methods. It is general problem area. My thesis consists as part of the exploratory research. An exploration typically begins with a search for published data and studies. During research I face many problems in a position to narrow down from its original broad base and define the issue clearly. I collected data from different sources and major proportion of data collected through internet, some books study. My research design is a master plan specifying the methods and procedures for collecting and analyzing the needed information.
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Chapter 2 Literature review 2.1 Corporate restructuring in Business corporations Over the 1980 and 1990, companies across the world have engaged in corporate restructuring activities. This elevates the question as to whether corporate restructuring actions are similar across national boundaries, or whether patterns of corporate restructuring are related to national institutional contexts. It also poses the problem as to the direction of changes: are companies restructuring towards new organizational forms, as has been claimed by some management authors. The term corporate restructuring is slightly difficult to define. According to Bowman and Singh (1989), restructuring include a important and rapid change along one or more of three dimensions: assets, capital structure or management. A most important difficulty defining the concept of restructuring is that there is 'a lack of systematic academic theory and evidence on the consequences of restructuring' (Singh 1993, p. 148). This hold especially for the third dimension of management. According to a study by the Harvard Business School (2), corporate restructuring has enabled thousands of organizations around the world to respond more quickly and effectively to new opportunities and unexpected pressures, thereby re-establishing their competitive advantage. (Andreas Kemper) defined that various field have contributed to the literature, numerous restructuring have failed in practice, which has results from empirical performance investigations of restructurings reveal a diverse spectrum of conclusion. While some companies have been very successful in their restructuring efforts, other has destroyed shareholder value. (Dale f Gray 1999) is defined that corporate restructuring and improved corporate governance is essential parts of economic reform programs under way in many countries. (Stijn Claessens 1999) Cross-country experiences suggest several important principles for successful systemic restructuring. It need satisfactory public resources, deep changes in institutions, rules of the games, and attitudes, an early and systematic evaluation of the size of the problem, design of an overall strategy, and prompt action. A dominant feature in the literature on the dimension of management has been the discussion on the shape of the 'new organization'. According to one persistent argument, we are currently witnessing a major break from the multidivisional form of organization seen in the past. Emerging organizational forms, referred to alternatively as 'N-forms' (Hedlund 1994), cellular forms (Miles/Snow/Mathews/Miles/Coleman 1997) or the individualized corporation (Ghoshal/Bartlett 1997), would be characterized in particular by less horizontal and vertical differentiation, and by more ad hoc internal linkages. Research on corporate restructuring has usually focused on one country (cf. Liebeskind/Opler/Hatfield 1996, Geroski/Gregg 1994), and cross-national study on corporate restructuring has stay relatively scarce (exceptions include Whittington et al.
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1999a, Frese/Teuvsen 1999, Buhner/Rasheed/Rosenstein 1997). This may be due e.g. to the be short of of right to use to comparable data sets, uncertainties in understanding foreign contexts, and the difficulties of conducting cross-national research (cf. Teagarden et al. 1995, Kohn 1996). Exploiting attach with six European business schools, this paper assesses patterns of corporate restructuring and changes in forms of organizing over the 1992-1996 period, using the results of a recent European survey (Pettigrew/Whittington/Conyon 1995). We look at comparisons and contrasts in the European evidence on restructuring, in order to assess whether new patterns of organizing are emerging at different places and at different paces across Europe. In responsibility so, we shall talk to some of the methodological problems associated with cross-national research. Business corporations are of central importance to economic activity at both the national and global levels. In 2002 there were 13 corporations in the world that had revenues in excess of $100 billion -- six of them American, three Japanese, two German, one British, and one British-Dutch. Of the world’s 50 biggest employers– 18 were American, nine French, seven German, six Chinese, four Japanese, two British, and one each Dutch, British-Dutch, Russian and Swiss. In At some point in history – although in many cases that history goes back more than a hundred years -- even the largest of these business corporations did not exist. These corporations grew large over time by developing the productive capabilities of their investments in physical and human capital and then realizing returns on these investments through the sale of goods and services, thus reaping the benefits of economies of scale and scope. In historical retrospect, that growth was not inevitable (even if, with careful research, it may be explicable), and one cannot assume that any particular corporation will be able to sustain, let alone augment, its current levels of revenue and employment in the future. Industrial corporations that have grown large often undergo major restructuring. (Maran Marimuthu 2009) The fundamental reason for carrying out corporate restructuring is to further enhance the long-term survival of firms through greater efficiency and cost-effectiveness. As a result, companies are jump to conduct financial restructuring as part of their corporate restructuring program. This involves some adjustment on their capital structure as there is a need to have changes on either their debt proportions or equity proportions. This article explores certain critical areas of capital structure. The argument here is based on the life cycle of a company, firm specific characteristics and type of business dimensions. This learn also present a conceptual understanding on capital structure in a given set of factors/variables. It is also postulated here that researchers should look into the possibility of remodeling their work on capital structure. McKinley and Scherer (2000) described restructuring as some major reconfiguration of internal administrative structure that is associated with an intentional management change program. This definition is consistent with Bowman and Singh (1993) description of organizational restructuring. There are three types of corporate restructuring transactions, first financial restructuring including recapitalization stock repurchases and changes in capital structure. Second is portfolio restructuring involving divestment and acquisitions and refocusing on core businesses,
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follow-on in change of the variety of business in the corporate portfolio, and the third is operational restructuring including retrenchment, reorganization, and changes in business level strategies.
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Chapter 3 Corporate spin offs 3.1 What are corporate spin-offs? Spin-offs divide one firm into two; current shareholders receive a pro-rata sharing of separate equity claims on a separation of the original firm’s net assets. Spin-offs occur when a parent firm distributes all or most of its holdings of stock in a subsidiary to the parent shareholders based on the proportion proportion to their holdings in the parent firm, on a pro rata basis. As a result, the subsidiary firm is no longer owned or controlled by the parent firm and there are two separate publicly traded firms. Prior to the spin-offs shareholders only own the parent firm stock, whereas after the spin-offs they own shares in both the parent and the subsidiary. In these dealings, no funds modify hands and the assets of the subsidiary are not revalued. A Corporate Spin-Offs is the separation of an existing company into two, usually a bigger one “the parent company” and a smaller one “the Spin-Off ”. ”. Corporate Spin-Offs can be the effect of restructuring of the parent firm or can be formed when employees use their skill acquired within the parent firm to exploit new ventures outside the parent firm. Corporate spin-offs are often the result of restructuring or reorganizations of the parent firm. Activities that are not inside the organization core competencies and that do not gather minimum performance requirements are also closed down or spun-off. Furthermore, sectors with high spin-offs frequencies are often sectors that experience a high level of cost-cutting activity. Deregulation seems to have been one of the driving factors in encourage the emergence of Corporate spin-offs in the energy and telecommunications sector. Corporate spin-offs might also be shaped when employees are not able to understand their ideas in the parent corporation. These employees want to use an unused potential based on their key experience acquired inside the parent corporation. Some of them are upset because the parent company does not allow them to pursue an opportunity, so they decide to leave the parent company. Others mark opportunities in the external environment and decide to pursue the opportunity themselves, somewhat sharing it with the parent firm. The Legal Perspective on Corporate spin-offs.
The legal definition of corporate spin-offs emphasizes the contractual basis of its founding as follows: In spin-offs the parent firm establishes one of its divisions as a new publicly traded firm and distributes the shares of this firm to the parent’s existing shareholders. It is approximately always structured as a tax-free transaction with no cash flow implications to the parent, spin-offs or shareholders.
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Figure 3
3.2 Key motivation for spin-offs Corporate Spin-offs companies have a variety of motivations for spin-offs, including management reasons, capital market factors, risks, tax benefits, marketing factors, and regulatory or legal reasons. Spin-offs can alleviate management problems of both parent corporations and spun-off firms, because both kinds of corporations have different lines of business and different business environments. Since the parent firms generally are large diverse operations, they cannot provide the kind of management financial and resource support that the subsidiary needs for continuous growth. In addition, some portfolio managers prefer pure play corporations. Investment professionals may be interested in one or the other of companies’ basic businesses, but not both. To the level that financial markets are incomplete spin-offs provide investors with a wider range of investment opportunities appealing to different investor clienteles. The issuance of separate financial reports on the operations of the subsidiary facilitates the evaluation of the company performance. This technique enables managers to uncover the hidden value of the subsidiary. Since parent firms and some subsidiaries often unrelated business lines, they also have different business risks which affect operating earnings. Parent firms sometimes spin-offs subsidiaries to protect both businesses from each other risks, which generally stabilizes the earnings of the parent firm. The spin-offs of a riskier subsidiary allow each corporation to finance its expansion based on its own growth rates and projections. Marketing concerns also prompt parent firms to spin off subsidiaries. The first concern is that consumers and suppliers will think parent firm is not devoted to its core line of companies if it has a not related subsidiary. The second concern is the connection of lines imperfect of business that are supposed as being incompatible. Therefore, having various business lines may cause uncertainty among customers, investors, and suppliers who identify a firm as offering incompatible products or services.
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An further significant motive for corporate spin-offs is to take advantage of tax benefits. Tax advantages can be achieved by the formation and spin-offs into natural resource royalty trusts or real estate investment trusts. As long as these entities pay out 90 percent of their earnings to shareholders, they are tax exempt, permitting the parent firm to shield income from taxes. Finally, laws and regulations may cause firms to spin-offs subsidiaries freely or involuntarily. As earlier mentioned, laws and regulations sometimes lead to involuntary spin-offs when complaints are filed to federal and state agencies. However parent firms sometimes spin offs their subsidiaries to split up regulated and unregulated firms or to keep away from legal hurdles associated with ownership of certain kinds of firms. A spin-off in such situation allows the unregulated firms to operate and expand unfettered by regulation.
3.3 Corporate spin-offs implication polices Measures towards Corporate Spin-Offs have the possible to produce better direct and indirect impacts on employment and competitiveness compared to other events that support the formation of new companies. This is due to the information that Corporate Spin-Offs tap into and profit from their previous experience and relations acquired within the parent firm to make the new business. Therefore they begin with a competitive advantage compared with other types of new firms. This produces low failure rates, higher growth, and longer-term constancy at corporate level. Policy options about Corporate Spin-Offs can therefore offer the possible to be more effective than measures expected at supporting normal firm start-ups. However it should be taken into account that measures about Corporate Spin-Offs should be well balanced in order not to handicap normal firm formation. Policy options to support Corporate Spin-Offs •
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•
•
Measures that promote the incentive to spin-off might be formed through
revised taxation schemes for equity holdings in Spin-Offs. Measures that help parent and Spin-Off firms manage with labor and organizational costs generated by the Spin-Off process. This might comprise the support given by the parent firm to the Spin-Off or be going to to cover the organizational costs of change for both firms. Measures that allocate more flexibility in labor relationships and encourage adequate labor arrangements, such as announcements, leaves of lack or transfers. Measures that add to the visibility of winning Corporate Spin-Offs and their wider benefits, for example using benchmarking of experiences and good practices.
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3.3.1 Implication for corporate polices The corporate policies of a huge diverse company are forced by its core business. After the spin-off parent firm and subsidiary firm can implement their own best possible policies. For the subsidiary the date of the spin-off is clearly the right moment to implement its own best possible policies, but particularly if the spun-off subsidiary is large, the spin-off is also the right moment for the parent to reconsider its own policies because the character of its assets has changed. In which discuss compensation, financing, dividend and other policies that are affected by the environment of the investment inv estment Opportunity set of the firm.
3.3.1.1 Executive compensation The investment opportunity set of a firm determines its compensation policy. They forecast that managerial compensation rises if the company has many growth options. This forecast is based on two hypotheses: first, the marginal product of investment decision makers is superior to the marginal product of supervisors; second, a company with growth options is riskier, which usually translates into higher risk for managerial compensation. Based on the statement that it is more complicated for shareholders to observe the manager of a firm that has many growth options than to check the manager of a firm with its assets largely in place, a firm with growth opportunities is likely to use a formal motivation plan that ties compensation to firm performance. Their prediction of incentive compensation based on accounting profits is unclear because accounting numbers are poor measures of performance in firms with growth options. However, they definitely forecast higher stock-based incentive compensation as percentage of total compensation in firms with growth options. This suggests that when a company has both divisions with assets in place and with growth options, and spin-offs also the assets in place or the growth options, the best possible compensation policy for each new company varies with respect to both the level and the companies of compensation. Particularly in divisions that have growth options changes might be extensive after the spin-off. First, the level of managerial compensation must rise because the CEO of the new company makes his/her own investment decisions and manages a firm that is riskier as a free standing company than as a division of a larger company. Second before the spin-off the division manager had partial decision rights, and his/her incentive compensation would mostly consist of bonuses based on accounting numbers of the division. After the spin-off the former division has it hold stock price. Therefore a large parts it managerial Compensation should be attached to the stock price of the new company.
3.3.1.2 Financing policy Financing policy explain that in companies that are made up of a combination of units with assets in place and units with growth options external financing of the investment opportunities of a growth-options unit by an equity issue is expensive because of an 15
asymmetric information difficulty with outside investors. The difficulty is determined by doubt about the value of the assets in place. Assume managers work in the interest of existing shareholders. Investors form out that manager who has private information that the assets in place of the firm are undervalued have no incentives to issue shares if the cost of issuing shares at bargain prices outweighs the net present value of the new project. Consequently, an equity offering implies bad news about the assets in place. This affects the price investors are ready to pay which in turn affects the decision to issue shares.
3.3.1.3Dividend policy The company dividend policy depends on the company growth opportunities. High growth companies pay low dividend to avoid constraints in investments, but low growth companies must pay high dividends as they do not have good opportunities for reinvestment of their cash flows. In the pre spin-offs company dividend policy is forced by the parent. After the spin-offs both companies can apply their own most favorable policies. Given the facts about asset diversity the most favorable dividend policy of the subsidiary will likely vary from the most favorable dividend policy of the parent. This can have repercussions for investors. An institutional investor who manages a fund that specializes in income stocks will sell the shares of a spun-off subsidiary that do not pay dividend income.
3.3.1.4 Other corporate policies The company investment opportunity set also has an impact on other corporate policies. The possible links between the company investment opportunity set and its accounting process choice. The companies leasing policy also will be affected: Barclay and Smith (1994) find that growth opportunities are completely related to capitalized leases as fraction of all fixed claims in the company. This supports their argument that financing new investment projects with senior claims such as capitalized leases limits wealth transfers from stockholders to existing bondholders and so helps to decrease the underinvestment difficulty that was discussed earlier. Finally, a good hedging policy is important for companies with growth options: it reduces the probability of default and thus increases the debt capacity of the company.
3.4 Gain from corporate spin-offs 3.4.1 Abnormal returns Earlier studies have investigated the size of the gains of spin-offs. Some of previous research shows that announcements of spin-offs are linked with significantly positive abnormal returns. In addition, Rosenfeld finds in his sample that the gains from spin-offs are greater than the gains from sell-offs. Schipper and Smith document a significantly positive abnormal return of 2.8% during the announcement period in a sample of 93 spinoffs, but they find no preannouncement period gain. Hite and Owers (1983) find
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significant abnormal returns of 3.3% during the announcement period but also find gains in the pre-announcement period. In Europe, spin-offs were uncommon before the 1990s. However, the last few years have seen a large number of European spin-offs. Veld and Veld-Merkoulova (2004) investigate a sample of European companies that completed a spin-off in the period 1987 to 2000. During these years most spin-offs in their sample occurred in the United Kingdom (70 spin-offs), followed by Sweden (24 spin-offs), Germany (14 spin-offs) and Italy (11 spin-offs). They find wealth effects for shareholders those are similar to the wealth effects that are documented for U.S. spin-offs: the average cumulative abnormal return at the announcement of the spin-offs is around 2.6%.
3.4.2 The ex-day puzzle After the announcement, it typically takes a number of months before the spin-off takes effect. At that point in time two separate exchange-listed firms are created. Both firms firstly have the same set of shareholders. However on the first day of trading – the ex date or allocation date of the spin-off transaction ownership changes: some shareholders sell shares of one firm but keep their shares of the other firm; other shareholders buy extra shares in one firm but not in the other. Also, new investors now have the chance to buy shares of the subsidiary. Just, researchers have found some puzzling evidence about abnormal price movements at or shortly after the ex date. Brown and Brooke (1993) investigate the behavior of stock prices of subsidiaries after the ex date. They find that subsidiary stock experiences an average negative abnormal return of around 4.3 % in the first 30 days after the ex date. They dispute that the need for institutional investors to rebalance their portfolios causes this negative abnormal return. They find that if the parent firm is in the S&P 500, the decline in stock prices is even higher. Their details are that managers of index funds are forced to sell the shares of the subsidiary because the subsidiary stock is not part of the index.
3.4.3 Tax issues Taxes pressure the gains from spin-offs. In the U.S., most spin-offs are structured as nontaxable distributions. If the unit to be spun off is not previously a legally separate subsidiary, but a department or a division, then reorganization under Section 368 of the Internal Revenue Code must take place first. Section 368 governs the tax-free transfer of assets from the parent firm to a subsidiary. After the subsidiary is formed, Section 355 of the Internal Revenue Code of 1954 describes the circumstances under which a subsidiary is acceptable to split from a parent corporation without the imposition of taxes. Important conditions are that the parent must distribute at least 80% of the stock of the subsidiary and that the distribution cannot be a device for the distribution of profits.
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3.5 Reasons for corporate spin-offs The benefits and costs of an incorporated firm are discussed. If the costs of integration are higher than the benefits, then large companies must divest one or more of their units. Mainly studies that attempt to explain the causes for spin-offs take the benefits as given and concentrate on the costs of integration.
3.5.1 The benefits of combining units In numerous cases it is competent to combine smaller companies into one large company. Coase (1937) argues that firms should be integrated if the costs of transacting within the firm are lower than the costs of using an external market. He identifies five basic extensions of his analysis: (1) Vertical integration; (2) information benefits; (3) economies of scale; (4) financial synergies; and (5) tax benefits.
3.5.2 The costs of combining units There are also costs of combining units. This subsection present cost based hypotheses for spin-offs. In broad, these hypotheses are not mutually exclusive.
3.5.2.1 Focus The focus hypothesis argues that spin-offs can improve the focus of the parent company. Focus on core activities is helpful for companies that have evolved in excess of time into big conglomerates of distinct assets. Divesting assets that are distinct to the core business of the company increases shareholder value. Some research investigates whether spinoffs improve focus and therefore increase the value of the company. They categorize spin-offs as own-industry spin-offs if the spun-off unit operates in the same firm as the parent firm, and as cross-business spin-offs if the spun-off unit operates in a different business. They think the firms of parents and subsidiaries different, of the parent. Their hypothesis is that in contrast to an own industry spin-off, a cross industry spin-off increases the focus of the parent company. They find facts that cross industry, focus increasing spin-offs have positive abnormal returns at the announcement, and therefore create shareholder value, while own industry spin-offs do not appear to create value. Dependable with the focus hypothesis find that the operations of the parent companies progress but they do not find evidence of performance improvement by the subsidiaries. Similarly, focus-increasing spin-offs have higher abnormal returns than non focus increasing spin-offs.
3.5.2.2 Diversity A further hypothesis also argues that not linked parts of the company must be spun off, but this hypothesis is more precise about the exact nature of the diversity in assets.In a multidivisional company the CEO makes decisions regarding the portion of funds across
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divisions or the encouragement of one manager instead of another. The managers affected by these decisions challenge to influence the result of these decisions. Such actions waste resources, but if the stakes are big then the incentives for influence activities are high. For example the prospect of layoffs creates influence costs since the managers of declining units try to protect their jobs. Jongbloed (1994) argues that activities designed to influence the CEO's decision include overstatements of productivity and the value of investment opportunities of the manager's own division or sabotage of the performance of the other divisions. In large companies, top management normally tries to benefit from financial synergies by channeling funds from cash divisions with assets in place to divisions with growth options that can use the cash more profitably.
3.5.2.3 Information a asymmetry symmetry A spin-off increases the number of traded securities on the stock market; the price system will become more informative. As a result the degree of information asymmetry between managers of the company and uninformed investors decreases, more informative price system improves the quality of investment decisions made by managers and reduces the doubt of investors about the value of divisions. This will lead to an increase in the value of parent company and subsidiary after the spin-off.
3.5.2.4 Merger and takeover facilitation A spin-off is incompetent way to transfer control of certain divisions to acquiring companies because if bidders are interested only in a part of the company, they do not have to take over the entire company. Bidders can negotiate directly with the shareholders of the recently spun-off subsidiary in its place of having to negotiate with the management of the parent company. Both parents and subsidiaries experience considerably more takeovers after their spin-off than co ntrol groups of similar companies. Chemmanur and Yan (2004) show that a spin-off can increase the probability of a takeover of a division. In their model, the management of a diversified company can mask its lower ability to run some units of the company by better ability to run other units. After the spin-offs, their lesser ability is revealed, and shareholders might vote in favor of a takeover when a bidder expresses interest. Also it is easier for a bidder to take over a smaller company. In their theory, a takeover does not essentially in reality have to occur: the increased chance of loss of control can force management to work harder to minimize that probability. On the other hand, management can give up control of the subsidiary to capable division managers when the spin-off is implemented.
3.5.2.5 Regulations Sometimes a split of a company is compulsory because of government laws or regulations. For example, in 1984 the U.S. government forced AT&T to split up into seven so-called Baby Bells (Pacific Bell, Ameritech, Southwestern Bell, US West, Bell Atlantic, BellSouth and Nynex) to undo its telecommunications monopoly.
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3.5.2.6 Wealth expropriation Finally, shareholders can basically gain by expropriating wealth from other claimholders of the company. For example, shareholders have gained at the expense of bondholders in the case of the spin-off of Marriott’s hotel management businesses (Marriott International) from its hotel properties (Host Marriott) in 1993. The spin-offs were extraordinary because the spun-off unit represented almost 80% of the value of the equity. Usually, the spun-off unit is much smaller than the parent. The parent company became highly leveraged because approximately all debt stayed with the parent (the initial plan called for even higher leverage). Because the asset base that might support the bondholder claims on the cash flows decreased, the claims of the bondholders lost value.
3.6 Corporate Spin-Off Processes In a broad logic, a Corporate Spin-Off process is the partition of an existing firm into two, usually a bigger one and a smaller one. The process consists of three phases, the decision phase, the separation phase and the post separation phase. The decision phase involves all factors important to the decision to spin-off. The separation phase comprises the strategic and organizational separation of the two firms. The post separation phase starts with the independent operation of parent firm and Spin-Off and ends when no more preferential agreements or dealings between parent and Spin-Off survive. The persons, assets and intangibles transferred from the parent firm make up a key element of the Spin-Off’s core business. Corporate Spin-Off processes involve deep changes in ownership, responsibility and liability for the Spin-Off’s actions. The aims of the Spin-Off process decide how the process is initiated, implemented, perceived and evaluated.
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Figure 4: The Corporate Spin-Off process
Depending on the motivations at the back Corporate Spin-Off process, two types can be famed. Restructuring-driven Spin-Offs are initiated by the parent firm for strategic or operational motives related to the parent firm. They are often the result of restructuring or refocusing activity of the parent firm. Entrepreneurial Spin-Offs are driven by one or more individuals who want to develop
an unused potential based on their experience acquired within the parent firm. These two types are presented below.
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Figure 5: Entrepreneurial vs. Restructuring-driven Spin-Offs
Restructuring-driven Spin-Offs can be regarded as a top down process since the source of the decision and the driver of the process is the parent firm. Research on 85 US Corporate Spin-Offs revealed the following effects of the Spin-Off Sp in-Off process on the parent: Excess share price improvements for the parent firm around the announcement date of the Spin-Off. Entrepreneurial Spin-Offs are bottom-up processes, where the source of the decision and the driver of the process is the Spin-Off entrepreneur. In evaluation to other start-ups, Corporate Spin-Offs combine significantly lower failure rates with the high growth of a new (or refocused) firm. It seems that there is a strong positive correlation between the complication and specialization of the Spin-Off’s business and the Spin-Off entrepreneur’s previous key experience in the field. Mutually with the increasing availability of venture capital in many European countries, more and more entrepreneurial personalities take the proposal to form a Spin-Off.
3.7 Accounting for corporate spin-offs Announcement of the spin-off pending the date it is completed, the parent accounts for the disposition of its subsidiary in a single line item on its balance sheet called Net Assets of Discontinued Operations or similar. The parent company also segregates the net income attributable to the subsidiary firm on its income statement in an account called Income from Discontinued Operations or alike. The spin-off is recorded at book value on the transaction date as follows: ,
,
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Figure 6 Parent's Journal Entry
dr. Retained Earnings
$$$
cr. Net Assets of Discontinued Operations
$$$
Subsidiary's Journal Entry
dr. Assets
$$$
cr. Liabilities
$$$
cr. Equity
$$$
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Chapter 4 Equity carve outs 4.1 What are Equity carve outs? o uts? The sale by a public corporation of a portion of one of its subsidiaries common stock through an initial public offering.The initial sale of common stock by a company of one of its business units. The initial public offering in general involves less than the whole amount of the stock in the unit so the parent firm retains equity stoke in the subsidiary. An equity carve out is occasionally followed by a distribution of the remaining shares to the parent stockholders. Also called carve-out split off IPO , ,
.
In equity carve-out, also known as as an initial public offering carve-out or a subsidiary initial public offering, the parent firm sells a portion or all of its interest in a subsidiary firm to the public in an initial public offering. The equity carve out creates a new legal entity with its own management team and board of directors, and provides a cash combination with proceeds distributed to the parent firm, subsidiary firm or both. An equity carve-out is the sale by a public company of a portion of one of its subsidiaries common stock through an initial public offering. Each carved-out subsidiary firm has its own board, operating CEO and financial statements, while the parent firm provides strategic direction and central resources. As in any other corporate restructure the parent firm can make available executive management skills, company and government relationships, and employee plans, and execute time-consuming administrative functions, freeing the subsidiary firm CEO to focus on products and markets. Figure 7
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4.2 Reasons for equity carve outs The empirically strong-minded motivations for equity carve outs which parent company state when announcing their future transaction. While it may not be in the interest of the parent company to declare all of the reasons for an equity carve outs (if an equity carve outs is agreed outs to sell an overvalued subsidiary companies) some abstract considerations regarding the sources of value creation for the parent company are also described. Mutually these two perspectives produce view of the reasons why firm connect in an equity carve outs.
4.2.1 Motivation of parent firms The motivation for an equity carve outs can be diverse. The final objective of these motivations must be the increase of shareholder value. A corporation may bring to a close on the basis of a strategic review that a definite business segment does not any longer fit into its generally long term business strategy and therefore decide to dispose of it, joint with the desire to exit a loss making business of its subsidiary company but may be lacking the capital to do so, and decide to find the required financing from external capital markets. Equity carves outs takings may be used to repay debt of the parent company or subsidiary company. A firm may propose to expand its investor base nationally or internationally if its subsidiary company is prepared in a different country. A firm may doubt that its subsidiary firm is valued appropriately by capital markets as part of the parent firm, and mean for a valuation more in line with the subsidiary firm peers. The equity carved out a subsidiary company to fulfill with regulatory requirements or because it wants to protect itself from liability claims in another legislation.
4.2.2 Sources of value creation In a miller-Modigliani world with perfect capital markets, the value of a company would only depend on the net present value of the company projects and not on how the company is prepared financially. A brief overview of the theoretical reasons why an equity carve outs could be expected to create value, if the assumptions of a perfect world do not hold.
4.3 Differentiating an equity carve-outs from other forms of restructuring A number of type differences between a variety of forms of portfolio and financial restructuring. An equity carve outs is diverse from all other forms of portfolio and financial restructuring restructuring in that it combines aspects of equally of these events, whereas mainly other mechanisms have a physically powerful tendency to be classified as either restructuring or financing. This double nature of equity carve outs implies the requirement to take into consideration the prime motivation of the parent company in carrying out the equity carve outs when analyzing short and long term performance. An equity carve outs differs from a spin-offs in smallest amount three aspects. First in spin-
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offs existing parent company shareholders receive share in the subsidiary company as a special dividend, while in an equity carve outs these shares are sold to new shareholder. Second spin-offs normally do not result in a cash flow to either parent company or subsidiary company, or both. Third spin-offs frequently results in a complete separation, whereas in an equity carve outs the parent company in most cases retains a stake in the carved-outs entity. Equity carves outs different from a seasoned equity offering in at least two aspects. First in a seasoned equity offering a parent company sell its own shares, while in an equity carve outs share of its subsidiary company are sold. Second share of the parent company have been trading before a seasoned equity offering, while shares of the subsidiary company have not been trading previous to an equity carve outs. In summary, here is a important body of evidence that shows, information asymmetry is a important factor in choosing to spin-off or carve out a division and shareholders’ wealth seems to increase in common following both spin-offs and carve-outs.
4.4 Accounting for equity carve outs 4.4.1 Strategic Rationale In adding to the strategic rationale for corporate restructuring outlined in our lesson on spin-offs and split offs, offs, equity carve-outs can be used to get the subsequent additional strategic objectives. Cash infusion – Cash proceeds can be distributed to Parent Company, Subsidiary Company, or both. Preparation for complete separation – set up a public market valuation for subsidiary company in preparation for a subsequent spin-off or split-off of parent company remaining interest. Transaction Structure Parent company stake in subsidiary company sold in a carve-out may consist of primary and secondary shares. Primary shares are issued by subsidiary company, and secondary shares are sold by parent company. Even though secondary shares are sometimes sold beside primary shares in an equity carve-out, they regularly represent a small portion of the total shares sold in the transaction.
.
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Figure 8
alike to monetization techniques employed in spin-offs and split-offs, Parent company may push down debt to subsidiary company prior to the initial public offering, and/or extract a special tax-free dividend from subsidiary company up to parent company outside basis in subsidiary company stock. Cash proceeds from the stock sale might be distributed to parent parent company to pay down debt, to subsidiary company for growth capital, and/or used by subsidiary company to repay an inter company loan from parent company, for example. Equity carve-outs are usually follows by a tax-free spin-off or split-off of parent company remaining interest in subsidiary company.
4.4.2 Tax Implicatio I mplications ns Primary or secondary shares are sold in the equity carve-outs has tax implications. If parent company sells secondary shares of subsidiary company, it recognizes a capital gain or loss equal to the cash earnings less its outside tax basis in subsidiary company stock. Though, if primary shares are issued the transaction is well thought-out a non taxable event to raise capital. Thus advertising primary shares is generally preferable to selling secondary shares. Carve-out does not usually exceed 20% of parent company equity interest in subsidiary company for several reasons. If parent company divests more than 20% of its voting interest in the subsidiary company, parent company would loses tax control of subsidiary company and any succeeding spin-off would fail to qualify for tax-free treatment. Consequently long as parent company retains at least 80% of subsidiary company, dividends from subsidiary company to parent company are tax-free under the Dividends Received Deduction. If more than 20% of parent company voting interest in subsidiary company is sold, parent company may no longer consolidate subsidiary company for tax purposes. Tax deconsolidation may result in a tax liability to parent company to the extent of any negative basis in subsidiary company.
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4.4.3 Accounting for Equity Carve-Outs The accounting treatment an equity carve-out depends on whether or not parent company maintains legal control of subsidiary company following the carve out, where legal control is generally defined as ownership of at least 50% of subsidiary company voting common stock. If parent company does not lose legal control, as is most often the case, the accounting gain or loss from the equity carve-out is recorded either on the consolidated income statement or as additional paid-in capital on the balance sheet, depending on whether primary or secondary shares are issued. If secondary shares are sold for an amount exceeding parent company book basis in the shares and parent company maintains legal control, parent company makes the following journal entry to record the carve-out. Parent Co Sells Secondary Shares
dr. Cash $$$ cr. Minority Interest $$$ cr. Gain on Carve-Out (Inc. Stmt) $$$ If primary shares are sold for an amount exceeding parent company book basis in the shares, parent company makes the following journal entry. Sub Co Sells Primary Shares
dr. Cash $$$ cr. Minority Interest $$$ cr. APIC (Bal. Sht.) $$$ If parent company does lose legal control of subsidiary company, it recognizes a gain or loss on its consolidated income statement despite of whether primary or secondary shares are issued. Also parent company will be required to account for its investment in subsidiary companies using the equity method of accounting rather than the consolidation method. Parent Co Loses Legal Control of Sub Co
dr. Equity Investment in $$$ Sub Co dr. Minority Interest $$$ cr. Net Assets of Sub Co $$$ cr. Gain on Carve-Out $$$ When primary shares are sold, regardless of whether or not parent company loses legal control, parent company recognizes a gain or loss for accounting purposes, but not for tax purposes. This temporary difference gives rise to a deferred tax liability that reverses when parent company eventually sells its secondary shares. On the other hand, if parent company sells the shares, a gain or loss is recognized for both accounting and tax
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purposes and no differed tax liability is created. Parent company makes additional journal entries when subsidiary company sells primary shares as follows. Accounting for Tax Effects
dr. Income Expense cr. DTL
Tax $$$ $$$
Timing Considerations Like a regular initial public offering, the equity carve-out must be prepared, filed with the SEC, marketed to investors, and priced. The entire process typically takes around 4 to 6 months to complete.
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Chapter 5 Divestments 5.1 What are Divestments? Divestments? Divestments pass on to the sale of an asset for financial, legal or personal reasons. For companies, divestment can refer to a firm selling off a portion of its assets, such as a subsidiary, to raise capital or to center of attention the business on a smaller core of goods and services. For investors divestment can be used as a common tool to protest exacting corporate policies such as a firm trading with a country known for child labor abuses.Divestment is a form of retrenchment strategy used by firm when they downsize the scope of their firm activities. Divestment usually involves eliminating a portion of a firm. Corporation may elect to sell, close, or spin-off a strategic business unit, major operating division, or product line. This move often is the final decision to eliminate not related, unprofitable, or unmanageable operations, Selling assets, divisions, subsidiaries to another corporation or combination of corporations or individuals. In finance and economics divestment or divestiture is the decrease of some type of asset for either financial or sale of an existing business by a company. A divestment is the opposite of an investment. Divestment is usually the result of a growth strategy. Much of the corporate downsizing of the 1990 has been the result of acquisitions and takeovers that were the range in the 1970 and early 1980. Corporations often acquired other businesses with operations in areas with which the acquiring company had little knowledge. After trying for a number of years to incorporate the new activities into the existing firms, many companies have selected to divest themselves of portions of the firms in order to focus on those activities in which they had a competitive advantage.
5.2 Reason to divestments In the majority cases it is not right away obvious that a unit should be divested. Many times management wills effort to increase investment as a method of giving the unit an opportunity to rotate its performance around. Portfolio models can be used to identify operations in need of divestment. Decisions to divest may be ready for a number of reasons.
5.2.1 Market share too small Companies may divest when their market share is too small for them to be competitive or when the market is too small s mall to offer the expected rates of return.
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5.2.2 Availability of better alternatives Companies may also make a decision to divest because they see better investment opportunities. Corporations have limited resources. They are repeatedly able to divert resources from a margin profitable line of firm to one where the same resources can be used to achieve a greater rate of return.
5.2.3 Need for increased investment Companies from time to time reach a point where continuing to maintain an process is going to need large investments in equipment advertising research and development and so forth to remain viable. Fairly invest the monetary and management resources, corporations may elect to divest that portion of the business.
5.2.4 Lake of strategic fit A general reason for divesting is that the acquired business is not constant with the image and strategies of the companies. This can be the result of acquiring a diversified company. It can also result from decisions to restructure and change the existing business.
5.2.5 Legal pressure to divestments Corporations can be forced to divest operations to avoid penalties for restraint of trade. Service Corporation Inc., a large interment home chain acquired so lots of its competitors in some areas that it created a regional monopoly. The Federal Trade Commission required the company to divest some of its operations to avoid charges of restraint of trade.
5.3 Implication to divestments strategy Companies might follow a divestment strategy by spin-off a portion of the firms and allow it to operate as an independent business entity. Companies may also divest by selling a portion of the business to another corporations. In 2005 Teleflex, U.S. $2.1 billions industries product manufacturer implemented a divestment and acquisition strategy to get rid of underperforming units while acquiring business in markets where it intended to expand its firm business. Although a firm business may be known as a target for divestment the implementation of divestment is not always easy. First a buyer must be found. This may be difficult for a failing firm unit. Just the once a buyer is found, then price must be negotiated. A lot of divestments are infertile by management expectations for the operation. Companies may well expect demand for the product to pick up. Management may also see the poor performance as a short-term setback that can be overcome with time and patience. Decisions to divest a firm can be seen as an admission of failure on the part of management and may lead to increasing commitment to the struggling business as a way of defensive management ego and public image. Divestment
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is not regularly the first choice of strategy for a firm. Though, as product demand changes and company alter their strategies, there will almost always be some portion of the firm that is not performing to management expectations. Such an operation is a prime target for divestment and may well leave the corporation in a stronger competitive position if it is divested.
5.4 Motives of divestments divestments Companies may have several motives for divestments. First a company may divest, sell businesses that are not part of its core operations so that it can center on what it does best. For example, Eastman Kodak, Ford Motor Company, and many other firms have sold various parts of businesses that were not closely associated to their core businesses. A second motive for divestments is to obtain funds. Divestments generate funds for the firm because it is selling one of its businesses in exchange for cash. For example, CSX Corporation prepares divestments to focus on its core push business and also to gain funds so that it could pay off some of its existing debt. A third motive for divestments is that a company’s break up value is occasionally believed to be greater than the value of the company as a whole. In other words, the sum of a companies individual asset liquidation values exceeds the market value of the companies combined assets. This encourages companies to sell off what would be worth more when liquidated than when retained. A fourth motive to divestments a part of a company may be to create stability. Philips for example, divestments its chip division called NXP because the chip market was so volatile and unpredictable that NXP was dependable for the majority of Philips's stock fluctuations while it represented only a very small part of Philips. A fifth motive for companies to divest a part of the business is that a division is underperforming or even failing.
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Chapter 6 Share repurchase 6.1 What are Share Repurchases? A program by which a corporation buy back its own shares from the marketplace and reducing the number of outstanding shares. This is generally a sign that the organization management thinks the shares are undervalued. Because a share repurchases reduce the amount of shares outstanding it increases earnings per share and tends to elevate the market value of the remaining shares. When a corporation does repurchase shares, it will typically say something along the lines of; we find no better investment than our own firm. Purchasing of its own shares from the public by a company whose management believes the shares are undervalued. Its objective is to raise the market value of the shares by reducing their number available for purchase. A shares buyback, also known as a share repurchase, is an organization buying backs its shares from the marketplace. You can think of a buyback as an organization investing in itself, or using its cash to buy its own shares. The idea is easy because a firm can not act as its own shareholder, repurchase shares are engaged by the firm, and the number of outstanding shares on the market is reduced. When this happens, the comparative ownership stake of each investor increases because there are smaller number shares, or claims, on the earnings of the firm. Buyback is reverse of issue of shares by a firm wherever it offers to take back its shares owned by the investors at a specified price; this offer can be compulsory or optional to the investors.
6.2 Method of share repurchases There are basically five ways by which a company can repurchase its own shares
6.2.1 Fixed price tender offer In a public fixed price tender offer a corporation offers to repurchase its shares at a fixed price for a specific quantity of shares the target number of shares. If the quantity of shares tendered is larger than the quantity of shares tendered, as long at it treats all shareholders, who, in common get priority over other shareholders. If the quantity of shares tendered is less than the target quantity, the corporation commits itself to buy back all shares tendered. Some tender offers are meant at eliminate shareholder servicing costs. A further, special case is a tender offer by a closed end mutual fund. It is well known that stopped end fund often trade at a discount. These buyback can be considered as partial liquidations or open-ending where the shareholders are allowed to redeem their shares.
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6.2.2 Dutch auction tender offer As an alternative of a single offer price, the Dutch auction specifies a variety of prices within which each tendering shareholder chooses his minimum acceptable selling price. Each shareholder informs the offering company of the quantity of share he is willing to sell and the minimum acceptable selling price. The offering company then pays to all shareholders the lowest price that will obtain the number of shares sought. Dutch auction tender offers can be more attractive to organizations than fixed price tender offers for several reasons. First if the goal of the repurchase is simply to reduce the number of shares outstanding, it is in general cheaper to repurchase a specific number of shares through a Dutch auction offer than through a fixed price offer. A fixed price tender offer the non tendering shareholder is effectively writing a put with a fixed exercise price.
6.2.3 Private or target share repurchases A corporation can also make a decision to buy back its own shares from a large investor. Peyer and vermaelen argue that on can differentiate three types of private transactions. First the repurchase can be measured as greenmail if the firm repurchases stock from a potential raider at a premium above the market price. These dealings were popular in the eighties when aggressive bids were common, but have all but disappeared in recent years. Second, the sellers might be insiders or employees who plan to sell shares after restrictions are lifted on restricted stock of shares or after the exercise of executive stock options. In these cases no premium is typically paid. Third the buyback could be at a premium above the market price, but not from an aggressive bidder, but simply because the firm believes its stock is undervalued.
6.2.4 Open market share repurchases The most common way to repurchases stock is through an open market share buyback program. In this case, the corporation instructs a broker to buy some shares on the open market. Even though open market buyback programs seem to be the cheapest way to repurchase stock, they are often subject to various restrictions on repurchase volume and price paid. The reality that open market buyback authorizations are not followed up by actual buyback decisions does not mean that managers are doing amazing unsuitable or unethical. This is reliable with the view that managers try to take advantages of undervalued share prices, but abstain from buyback stock if the market becomes efficient. On the other hand, it could mean that the company discovered new growth opportunities, which made shares buyback relatively unattractive. furthermore to the extent a repurchase authorization allows a company to take advantage of buying undervalued shares, all organizations should request such authorizations, in spite of of whether they actually plan to complete the repurchase. This supposed to be particularly the case where obtaining authorization requires shareholder approval such as in Europe.
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6.2.5 Repurchases involving derivatives Artificial buyback are repurchases that are executed with the use of derivatives. In common three types of programs can be well-known: 1- writing put options, 2- buying collar and 3- buying forward contracts. Counterparties in the transactions are investment banks who consequently hedge their risk. The main difference with other repurchase methods is those synthetic derivatives allow a firm to take advantage of an undervalued share price without using cash. So in some ways these types of contracts are ideal for corporations that consider their shares are undervalued but have nonflexible capital expenditure needs, large growth opportunities and face large costs of financial suffering. In other ways these contracts are company commitments and decrease the inherent flexibility of open market buyback programs. When a firm sells a put it commits itself to buyback a specific number of shares if the stock price falls below the exercise price at the expiration date. If the organization is right the option will finish out of the money and the firm simply pockets the premium. Obviously if the firm is wrong or the market has not corrected the undervaluation at the time of the exercise the option to settle the option by issuing share, so even under this situation, the put writer will not have to use any cash to settle its obligation, there purchase avoiding cost of financial distress. When a firm buyback shares through a forward contract, no cash will have to be paid at the time of the initiation of the contract, and if the firm made the right bet (stock price is above the forward price at maturity) they will receive cash. If a company was wrong and the stock price ends up below the forward price, the organization would also have the option to resolve by issuing shares. Finally when the firm purchase a collar (buy a call and sells a put) the exercise price of the contracts will be set so that no cash is paid or received at the time of the contract. The case of forward contracts, if the corporation was indeed undervalued at the time of the buybacks, it will receive cash at the maturity date of the contract. If the corporation was incorrect it will have the option to settle the put by issuing stocks.
6.3 Objective of share repurchases Shares may be repurchases by the organization on account of one or more of the following reasons
6.3.1 Unused cash If they have vast cash reserves with not a lot of new profitable projects to invest in and if the firm thinks the market price of its share is undervalued. Reliance's recent buyback, however, corporations in emerging markets like India have growth opportunities. For that reason applying this argument to these corporations is not logical. This argument is valid for MNCs, which previously have sufficient R&D budget and presence across markets. While their incremental growth potential limited, they can repurchase shares as a reward for their shareholders.
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6.3.2 Tax gain While dividends are taxed at higher rate than capital gains corporations prefer repurchases to reward their investors instead of distributing cash dividends, as capital gains tax is normally lower. At here, short term capital gains are taxed at 10% and long term capital gains are not taxed.
6.3.3 Market perception By purchasing their shares at a price higher than prevailing market price firm signals that its share valuation should be higher. In October 1986 stock prices in US started crashing. Expecting further fall many firms like Citigroup, IBM et al hav e come out with repurchase offers worth billions of dollars at prices higher than the existing exis ting rates thus stemming the fall.
6.3.4 Exit option If a corporation wants to exit a particular country or wants to close the corporations it can offer to repurchase its shares that are trading in the market.
6.3.5 Increase promotion stake Some corporations repurchase stock to contain the dilution in supporter holding, EPS and reduction in prices arising out of the exercise of issued to employees. Any such exercising leads to rise in outstanding shares and to drop in prices. This also gives scope to takeover bids as the stock of promoters dilutes. Technology firms which have issued ESOPs during dot com boom in 2000-01 have to repurchase after exercise of the same. However the logic of repurchase stock to protect from hostile takeovers seems not logical. It may be well-known that one of the risks of public listing is welcoming hostile takeovers. This is one technique of market disciplining the management. Though this type of repurchase is touted as protecting over-all interests of the shareholders, it is accurate only when management is considered as efficient and working in the interests of the shareholders.
6.3.6 Escape monitoring of accounts and legal controls A firm wants to avoid the regulation of the market regulator by delisting. They avoid any public scrutiny of its books of accounts.
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6.3.7 Show better financial ratio Corporations try to use repurchase method to show better financial ratios. When a corporation uses its cash to purchase stock, it reduces outstanding shares and also the assets on the balance sheet (because cash is an asset). Therefore, return on assets (ROA) actually increases with reduction in assets, and return on equity (ROE) increases as there is less outstanding equity. If the corporation earnings are identical before and after the repurchase earnings per share (EPS) and the P/E ratio would look better even though earnings did not improve. Because investors carefully scrutinize only EPS and P/E figures, an improvement could jump start the stock. For this approach to work in the long term, the stock should truly be undervalued. In general the intention for the repurchase is a mix of any of the above reasons. Sometimes Governments nationalize the firms by taking over it and then compensates the shareholders by repurchase their shares at a predetermined price. Reserve Bank of India in 1949 repurchases the shares.
6.4 Dividends vs. Share Repurchase Plans If a corporation is profitable, it will look to return wealth to its shareholders or investors in the corporation. While the approval in share price is often its own reward, if the organization is still profitable after paying expenses and taxes, it may still have money available. Whereas many corporations may choose to reinvest this cash in new projects, others may also wish to pay out dividends or repurchase its own stock through a share repurchase plan.
6.4.1
The Facts
If a corporation has surplus profits after taxes, it may choose to distribute the money to stockholders by declaring a dividend. A dividend amount is resolute and then each investor receives that amount, multiplied by the number of stocks he owns. In a share repurchase plan, the corporation repurchases outstanding shares from its stockholders, reducing the number of stock on the market and increasing the earnings per share, due to the lower number of available shares.
6.4.2 Function A dividend program is designed to stock profits with investors in the organization. Many organizations can and do offer regular dividend payments, which are striking to investors looking for the steady income dividends provide. Shares buyback plans are normally used to boost a stock whose price is flagging. By purchasing its own shares, a corporation may be indicating that it feels that the best place to invest its money is with itself, which increases investors' confidence.
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6.4.3 Benefits By offering and paying reliable dividends, a corporation can raise its stock price because more investors will be looking to take advantage of the consistent income. At the same time, many shares offer a dividend reinvestment program (DRIP), allowing stockholders to put their profits reverse into the corporations, thus increasing their investment. In a share buyback plan, the firm normally pays greater than the trading price of the stock to repurchase the shares, to give investors a reason to sell.
6.4.4 Considerations Whereas many corporations offer regular dividends, and investors buying stock with the expectation of receiving these payments, dividends are not guaranteed. Still the strongest blue chip shares stock can have a bad quarter or year and suspend dividend payments. Share buyback plans are normally a one-time offer. Corporations do not regularly repurchase their own stock, and there is no guarantee that they will do it again or that the stock price will increase even if you sell.
6.4.5 Warning Dividends and share buyback programs are much related in that the firm is distributing profits to investors. In the history dividends were taxed at the lower rate, while dividends were taxed as ordinary income. On the other hand, as of 2009, both are taxed equally. While dividends are paid repeatedly, you should consult a tax adviser before taking advantage of any share buyback program. You may want to hold the shares and wait for the price to increase.
6.5 Share repurchases and the protection of Shareholders The risk faced by shareholders depends on the kind of buyback involved. In a discriminating repurchase the business acquires shares from one or more specific shareholders only. The reason may be to provide accommodation a shareholder in a closely held business who upon reaching retirement age wants to withdraw her investment from the corporation. Getting rid of a worrying shareholder is another motivation. It stands to reason that the price paid by the corporation is basically important. If it is too low down, the non selling shareholders will benefit at the expense of the vendor. This is mostly problematic if the shareholder is being coerced into selling her shares to the corporation, but is also a matter in consensual sales where the corporation is withholding price sensitive information from the shareholder. Should the price be also high, the value of the shareholding of non selling shareholders will be diluted. Shareholder defense can be achieved in different ways. Some jurisdictions prescribe procedural requirements for buybacks while others rely primarily on substantive principles of fairness.
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6.5.1 The United Kingdom As the standard of capital protection applies in the United Kingdom, buybacks and redemptions can in wide-ranging be made only out of distributable profits or out of the proceeds of a fresh issue of shares. By way of exception, private corporations may buyback or redeem their shares out of share capital, although distributable profits and the proceeds of a fresh issue of shares must be tired first so that the resultant capital reduction is limited to the allowable capital payment. The type of shareholder approval needed and the technical requirements depend on the kind of buyback that is involved. A difference is made between off market repurchases, market repurchases and repurchases out of capital.
6.5.2 Off-market repurchases A corporation may obtain its shares under an off market contract that has been approved by special resolution of the shareholders. In a public corporation the resolution may remain valid for a maximum period of 18 months. Minority shareholders are protected by the voting exclusion that applies in respect of the shares that will be acquired in the off market buybacks. The individuality of the vendor shareholder and the terms of the repurchase must also be disclosed. Any difference of the contract must be approved by special resolution, subject to similar requirements. It is clear that coercive buybacks are not possible as there must be a contract between the corporation and the vendor shareholder that must be accepted by the non selling shareholders.
6.5.3 Market repurchases Even though an ordinary rather than a special resolution is required to approve market buybacks, the resolution must be stuck with the registrar in similar fashion as a special resolution. The approval must specify the maximum number of shares that may be Acquired, the maximum and minimum prices, and the date upon which the right expires. The expiration date for authority in a public corporation may not be later than 18 months after the passing of the resolution. The authority could be conditional or unconditional, and could either be wide-ranging or refer to shares of a specific class or description. Once the market buybacks has been made, the accurate terms of the contract including the maximum and minimum prices paid must be disclosed in a return submitted to the registrar. The Financial Services Authority’s (FSA) Listing Rules that apply to listings on the London Stock Exchange need equal treatment once more than 15 per cent of a corporations equity shares is to be acquired. Such buybacks are referred to as substantial
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market purchases and must be carried out by way of a partial offer to all shareholders or by way of a tender offer.
6.5.4 Repurchases out of share capital The repurchase of shares out of capital, which is likely for private corporations only, is subject to extra requirements pertaining to publicity and timing. The payment of the consideration elsewhere of capital must be approved by special resolution. The special resolution will not be valid if not the statutory solvency declaration by the directors and the auditors’ report is available for inspection by members at the meeting passing the resolution. Members whose shares are being acquired may not vote in deference of those shares. A protection device which is available only for buyback out of capital is the right to object to the approval resolution. Any nonconforming member and any creditor of the corporation may apply to court for the cancellation of the resolution. The court may possibly order that the dissentient members be buy out by other members or by the corporation and may make any order for the defense of the dissentient creditors. It appears that the court may not make any other order on the request of a shareholder than for that shareholder to be bought out, which clearly limits the situation where shareholders would make use of this right. The existence of a shareholder right of objection in buybacks out of capital appears to be irregular. While it could make wisdom, in a system relying on the principle of capital maintenance, to provide such additional protection to creditors when share capital is used to fund a buyback, shareholders face the same risks in spite of of the source of funding. It is achievable that the right to object was made accessible to shareholders only because such a right was being inserted for creditors and it was quite easy to extend it to shareholders.
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Chapter 7 Corporate recovery 7.1 What is Corporate Recovery? Corporate recovery is the word given to the rescue undertaken by professional accountants, who are professionally qualified, to assist the management of corporation in nursing a firm in financial and other difficulty bac k to health. A situation in which a corporation is saved from insolvency by means of restructuring, debt management or external investment
7.2 Need for corporate recovery If your company is in need of restructuring its debt, the services of a corporate recovery examine can help you make the change by guiding your objectives and presentations towards building a more productive and balanced approach in future extension by handling current debt. Excessively often company and businesses alternative to paying for a corporate recovery service only when the situation has turned dire and their corporation is in deep water without an oar left to paddle. Doing company as usual when creditors are storming the may not be practical and the directors have no new skills to deal with the new situation. So as to be while director rotate to a professional debt restructuring service, but it may be turn to a professional debt restructuring service before execute has been sharpened and the company debt can be restructured. The earlier a company turns to a corporate recovery service, the better. A corporate recovery service has its example in time management spiritual leader who used to make complicated charts teaching managers and staff how to be more cost efficient. What they bring with them now is a group of qualified managers with a set of steps that can be taken to bring a firm back from its downward curved into insolvency. Some of the steps so as to a corporate recovery service takes are to begin by opening discussions with creditors to work out a plan to keep the company working while going through recovery. After that step is, of course, to see for ways to get money from the corporation assets while allowing the basic infrastructure to exist and continue to do business. Division of looking for compulsory funds might mean making adjustments in the corporation hierarchy as well as looking for sources of returns from without the corporation. Obviously, if the corporate recovery services team has been called when the insolvency situation is very terrible then selling off assets before the creditors group in may be the only answer to avoid out and out plunder of the corporation's property. Although it might sound tongue in cheek to be worried about the costs of a corporate recovery team when the company is at risk for losing the whole thing, costs to discuss with with a professional team are usually minimal or free. Fees are really deferred until the restructuring process have been completed and the success of that restructuring would 41
have some weight on the authentic fees assessed even though an agreement can be reached before that when the team agrees to the project.
7.3 Corporate recovery strategies 7.3.1 A contingency approach to recovery The contingency approach to the design of recovery strategies is very important a horses for courses approach. As through any other feature of strategy, a one size fits all philosophy is equally dangerous and wrong. The exacting circumstances of the business must be analyzed to determine the action needed. It is important to reminder that the options I shall talk about below are not mutually exclusive; in other words, it may possibly (and, indeed, desirable) to select and implement several of these strategies either simultaneously or sequentially.
7.3.2 Management changes An increase of the current team is quite common in recovery situations in exacting, the appointment of a new chief executive officer. In carrying out a transformation at Continental Airlines, a consultant working on the project became President, after that cleaned out’ the existing management at every level. He wanted forgiveness from wronged customers, and shaped a ‘new look’ image by refurbishing aircraft and terminal furnishings.
7.3.3 Asset reductions A huge majority of successful recoveries engage cash generation strategies, with divestments being the most common. A producer may select certain plants for closing with a view to rationalizing production. Marks & Spencer recently announced it was to close up all its stores outside the United Kingdom to enable it to focus on its core market. In announcing the closing of its eighteen French outlets, it received heavy criticism for failing to consult with and inform local staff. C&A is a further high street retailer that announced a closure of stores; it determined to withdraw from the United Kingdom market entirely and focus on what it felt to be its core market in mainland Europe. The existence of major equity in the plants or stores being closed may well provide much needed cash injection to an ailing corporation. A sale is made and leaseback is another possible cash generation option that utilizes equity in properties owned by corporations. In some case, divestment involves the selling of complete firm units or brands; large multinational often select non core businesses for divestment.
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7.3.4 Cost reduction The cost reduction strategies are used more commonly by companies that fail to recover than those that do. Despite being what some would believe one of the more obvious options for a declining corporation, it is clear that such a strategy is not enough on its possess. One technique to reduce costs might might be throughout throughout the implementation of a redundancy programmed. Concern must be taken to make sure that this will not result in unnecessary deficiencies in knowledge and skills. There is an increasing fashion towards reducing the number of traditional full time staff in favor of creating a margin of part time, informal and self-employed workers. A reduction in committed and fixed overheads will carry about a flexibility and compactness that may have eluded the declining company. Outsourcing might be measured for non core service functions. Activity based costing can emphasize the true cost of carrying out functions in house and facilitate a fairer assessment to be made with external agencies willing to provide these services. The restructuring procedure referred to earlier may lead to a compliment, leaner corporations with a corresponding reduction in managerial overheads. And just-in-time purchasing and production methods can get rid of the high costs of stockholding. Maybe new production technology can be hold to reduce unit costs.
7.3.4 Product-market repositioning The outstanding organizations studied by Tom Peters and Bob Waterman understood their customers superior than their competitors did. The deliverance of superior products and levels of service to customers should be proceeding by a systematic analysis of their needs and expectations. I have previously referred to the need to assessment pricing policies, and further aspects of the marketing mix should be subjected to a similar analysis. A decision can be taken to redefine the target market, or to make separately particular segments and approach each with a unique offering. Healthy products and brands, or replacing ageing products within a brand portfolio might be a solution. Once again, Marks & Spencer is a useful case in point. As an effect of using up to date management accounting techniques such as customer account profitability, it might even be decided to take out products from some market segments and to focus resources on more profitable groups of customers. A number of United Kingdom banks have reached this conclusion. An in detail analysis of product costs can show the way to a better understanding of true product profitability. A rationalization of product lines strength is the result. The approach that overheads are allocated and assign may need to be addressed using an activity based approach. A good accepting of cost drivers is essential. Marketing is general to both successful and unsuccessful recovery situations. The successful organizations are likely to combine it with a more fundamental product market reorientation and through acquisitions.
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7.3.5 Investment in R&D Having survived the short-range, establishing a long term competitive advantage must be high on the corporations list of priorities. Investment in research and development may be a necessary element in such a method for long term success. In segments such as technology and pharmaceuticals, but is of vital importance. Research and development does not all the time lead to the development of breakthrough products, but may basically result in an improved version of an existing product. This as well can give the company a competitive edge over its competitor.
7.3.6 Acquisitions A method of growth, an acquisition has a lot of advantages over the whole option. Market share can be increased with instant effect, rather than having to remain for aggressive pricing and promotion policies to have an impact. Payment for the acquired organization can be made in shares rather than cash, or a combination of the two. At any time purchasing of intangible assets such as goodwill and brand names possibly will be of great benefit, especially if the turnaround involves developing new growth markets in which it is at present unknown. Asset stripping and possible synergy is additional attractive opportunity that an acquisition might present. The economies of scale that must be available from better operations will increase competitiveness. c ompetitiveness.
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Chapter 8 Analysis 8.1 Case Study The case discusses the company 2005 plan; a six-year long organizational restructuring implement conducted by the US based Procter & Gamble global leader in the fast moving consumer goods industry. The case examines in factor, the important elements of the restructuring program as well as changing the organizational structure, regulate the work processes and restore the corporate culture. The case complicated on the mistakes devoted by Durk Jager, the previous CEO of P&G and examines the reasons as to why Organization 2005 program did not deliver the desired results. Finally, the case talks about how Alan George Lafley, the new CEO, goes faster the initiatives under the Organization 2005 program and revived P&G' financial performance. Change in Organization Structure P&G had been prepared along geographic lines with more than 100 profit centers. Under Organization restructuring 2005 program, P&G sought to reorganize its organizational structure from four geographically-based business units to five product-based global business units - Baby, Feminine and Family Care, Beauty Care, Fabric & Home Care, Food & Beverages, and Health Care. Introduction The US based Procter and Gamble (P&G), one of the major fast touching consumer goods companies in the world, was in deep problem in the first half of 2000. The company, in May 2000, announced that its earnings growth for the financial year 19992000 would be 7% instead of 14% as announced earlier. The news led P&G' stock to lose $27 in one day, clean out $40 billion in its market capitalization. To add to this, in April 2000, P&G announced an 18% decline in its net profit for January May 2000 quarter. For the first time in the previous eight years P&G was showing a decline in profits. In the late 1990s, P&G faced the problem of inactive revenues and profitability. In order to increase speed growth, the erstwhile P&G President and CEO, Durk Jager (Jager) officially launched the Organization restructuring 2005 program in July 1999. Company 2005 was a six-year long organizational restructuring exercise which included the consistency of work processes to expedite growth. Through the implementation of the program, P&G meant to increase its global revenues from $38 billion to $70 billion by 2005. According to analysts, though company 2005 restructuring program was well planned, the implementation of the plan was a failure. Analysts assumed that Jager concentrated more on development of new products rather than on P&G' well-established brands. Forecaster felt, and Jager himself admitted, that he did too many things in too short a time. This resulted in the turn down of the company revenues and profitability. Following a brief stint of 17 months, Jager had to quit his post. In June 2000, Alan George Lafley took over as the new president & CEO of P&G. Under Lafley, P&G seemed to be on the right path. He was bright to turn the company around through his excellent planning, execution and focus. Through Lafley at the controls, P&G 45
financial performance improved significantly. The company share price turn up by 58% to $92 by July 2003, as against a fall of 32% in S&P 500 stock index. The cost of this program was expected to be $1.9 billion and it was estimated to generate an annual savings (after tax deductions) of approximately $900 million per annum by 2004.
8.2 Corporate Restructuring: General Motors, all along with many other us based companies, go through a decline in stock market activity and overall company finances following the attacks of September 11, 2001. The firm increasing costs of retiree retiree health care, pensions and benefits have surpass expected rates of return, impelling GM to develop a corporate restructuring program (General Motors, 2006). Subsequent $10.6 Billion loss in 2005 company decided to carry out its three year restructuring strategy, which take in the closure of nearly a dozen manufacturing plants, making significant job cuts, introducing new automobile lines, and redeveloping General Motor’s overall marketing strategy (General Motors, 2006). Most in recent times, General Motors announced it would consider a joint venture with competitors Renault and Nissan; however, efforts to form the alliance failed. Generally, the company still trusts it is on track with the new plan and CEO Rick Wagoner believes that both job cuts and plant closures are necessary for GM to get its costs in line with other major global competitors. Throughout the implementation of long term corporate restructuring, company plans on developing promising new product lines; as a result, increasing market share, improving product quality, and Increase Company finances. In the first quarter of 2006, general motor earned nearly $400 million in sales revenue representing the potential long-term benefits of such a plan (General Motors, 2006). Company was also able to cut its annual dividend from $2 per share to $1 per share, saving the general motors nearly $565 million a year (General (General Motors, 2006). Through recent company reduce reduce as well as health health care benefit reductions taking effect, General Motors possibly will potentially reduce company costs of up to $7 billion by the end of 2006, $1 billion further in savings than previously projected, saving the general motors nearly $565 million a year (General Motors, 2006). Closing down plants, assembly lines, and reducing employee numbers will very much reduce additional firm costs; allocate the money to benefit better product development. Through improving sales, company can open new plants and change existing plants to maximize the quality qu ality and efficiency of output.
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8.3 Case study: Reconstruction of company A Ltd, has became sick since a few years. The management feels that the company has recently turned the corner. Balance sheet of the company as at 30 June 2009 and other relevant particulars are given below.
Balance Sheet on 30 June 2009 Liabilities Equity share capital of Rs.10 each fully paid up 6% preference share capital of Rs.100 each fully paid up 9% Debenture of Rs.300 each fully paid Trade creditor Expenses creditor
Rs.
Assets Land and Building Plant and Machinery Stock Sundry Debtor Cash and Bank balance Profit and Loss account
6,00,000 2,00,000 3,00,000 400,000 50,000 ---------------15,50,000
(a) (b) (c) (d)
Rs. 1,00,000 2,00,000 2,00,000 2,00,000 30,000 8,20,000
--------------15,50,000
Land and building are worth Rs.400, 000. Stock and sundry Debtor are expected to fetch 20% less. Equity shares are to be reduced to Ra.2.50 each, fully paid up. Preference shares are to be reduced to Rs.50 each, fully paid up the rate of preference dividend being raise proportionately. (e) Debentures are to be reduced to Rs.200 each fully paid up the rate of interest being raised proportionately. (f) Trade creditors and expense creditor will wait for payment and continue business on existing terms if 20% of their dues are paid formalities. Some of Director wants to go in for capital reduction and some others prefer external reconstruction. You are required to prepare Reconstruction Accounts, Realization Accounts and two sets of Balance Sheet as may be appropriate under the above alternative schemes giving effect to the various points indicated.
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Accounting for internal Reconstruction Scheme Capital Reconstruction A/c To provision for doubtful debts A/c To Stock A/c To Cash /Bank A/c To Profit and loss A/c To Capital reserve A/c
Rs. 40,000 40,000 20,000 8,20,000 30000
Rs. 3,00,000 1,00,000
By Land Building A/c By 6% Preference share A/c By 9% Debentures A/c By Equity Share Capital A/c
1,00,000 4,50,000
9,50,000
9,50,000
Cash/Bank A/c
To Balance B/d To Equity Share Capital A/c
Rs. 30,000 100,000
Rs. 20,000
By Capital reconstruction A/c By Trade creditor A/c By Expense Creditor A/c By Balance B/d
80,000 10,000 20,000 130,000
130,000
A ltd (reduced) Balance sheet as on 30Jun 2009 Liabilities Issued and Subscribed 100,000 Equity share of Rs.2.50 each fully paid up Opening balance of capital stands at Rs.600,000 under scheme of reconstruction and Rs.100,000 issued during year 2000 12% preference share of Rs.50 each fully paid up Capital Reserve 13.5% 1000 Debenture of Rs.200 each fully paid A Current Liabilities: Trade creditor Expense Creditor B Provisions
Rs.
250,000
100,000
30,000 200,000 320,000 40,000 Nil 940,000
Assets Fixed Assets: Land and Building 100,000 Add: Appreciation 300,000 Plant and Machinery Investment Current Assets: Stock in Trade Sundry Debtors 200,000 Less: Provision For doubtful debt 40,000 Cash at Bank Loan and Advance Miscellaneous Exp
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Rs.
400,000 200,000 Nil 160,000
160,000 20,000 Nil Nil
940,000
Accounting for External Reconstruction Scheme Calculate of purchases consideration Rs Amount payable to: Equity shareholder (60,000 share @Rs2.50 each) 6% Preference shareholders 9% Debenture holders Trade Creditors Expense Creditors
150,000 100,000 200,000 80,000 10,000 ----------540,000 -----------
Cash Accounts To Balance A/c To Equity share Capital A/c
Rs 30,000 100,000
By Formation Exp A/c By Vendor A/c By Balance c/d
130,000
Rs 20,000 90,000 20,000 130,000
Realization A/c To land and Building A/c To Plant and Machinery A/c To Stock A/c To Sundry Debtor A/c To Cash A/c To Cash a/c paid trade &expense creditor
Rs 100,000 200,000 200,000 200,000 30,000 90,000 1,190,000
By Trade Creditors A/c By Expense Creditor A/c By A (new) Ltd A/c Purchase consideration By 6% Preference share Capital By 9% Debenture A/c
Rs 400,000 50,000 540,000 100,000 100,000 1,190,000
Equity Shareholder A/c To Profit and loss A/c To equity shares in A (new) Ltd A/c
Rs 820,000
By Balance B/d By Realization A/c
150,000 970,000
Rs 600,000 370,000 970,000
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A (new) Ltd. (and reduced) Balance Sheet as on 30 June 2009 Liabilities
Rs
Assets
Share Capital
Fixed Assets
Issued and Subscribed 100,000 Equity shares of Rs.2.50 each fully paid up 2000 12% Preference shares of Rs.50 each fully paid up Reserve and Surplus Capital Reserve Secured Loans 13.5% 1000 Debenture of Rs.200 each fully paid Current Liabilities Trade Creditor Expense Creditor
Land and Building Plant and Machinery Investment Current Assets Stock in Trade Sundry Debtor 200,000 Less: Provision For Doubtful debt 40,000 Cash at Bank Miscellaneous Expenses Formation Expenses
250,000 100,000
50,000 200,000
320,000 40,000 960,000
Rs 400,000 200,000 Nil 160,000
160,000 20,000 20,000
960,000
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Chapter 9 Conclusion Even through corporate restructuring as a mean of enhancing shareholder value is gaining important in the corporate world. The research is related to the process of corporate restructuring. In our research I conclude that corporate restructuring is changing the organization big change in internal structure, such as changes in assets and financial structure. Corporate restructuring may take place as some forms such as acquit ion leveraged buyouts hostile take over or a merger. Some of reasons in which company adopt the method of corporate restructuring with a motive to increase the shareholder value. Corporate restructuring allow focusing on assets use and profitable investment opportunities, to reorganize or divest less profitable or loss making business or products. The corporation can also improve value through capital restructuring and can innovate securities that help to reduce cost of capital. Company is reorganizing of faction such as sales marketing and distribution. In our research I conclude that corporate restructuring has enable thousands of companies around the world to respond more quickly and effectively to new opportunities and unexpected pressures, and get competitive advantage. In this regard the distinguishing factor of the success or failure of corporate restructuring may lie more in the process by which the specific strategies are implemented rather than in their content Each of the three modes of corporate restructuring portfolio restructuring financial restructuring organization restructuring has different strategic legal financial and organizational implications which are to be addressed correctly which formulation and implementing which are to be addressed correctly which formulating and implementing any corporate restructuring move. In financial restructuring be able to be seen as a means that can ensure the company is making the most efficient use of available resources and thus generating the highest amount of net profit. In portfolio restructuring is refer to changes in the sets of companies comprising the corporation to create a move effective configuration of business and increase effectiveness in combining lines of business. Some of methods of corporate restructuring are showing positive results in adopting companies. There are many examples of corporate restructuring which just did not produce the desired benefits and had to be reversed on a number of occasions. It is to be noted that favorable financial pay off from any corporate restructuring move is always the outcome of a well thought out programme for strategic repositioning of the concerned firm. In corporate spin offs Shares in the new company are distributed to parent company shareholders. The spin-offs company goes public. In addition, spin-offs may result after major shifts in the economic environment affecting corporations and their subsidiaries. Motivation contracts tied to the performance of the common stock of stock of the parent firm may not be meaningful for managers in the subsidiary. I conclude that some parents companies decide to spin offs subsidiaries because they believe that all their lines of business are not accurately valued in the capital market. A spin-off also engages the
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research of a plan of reorganization, which serves as the agreement between the parent and subsidiary for the specifics of the spin-off. Corporate Spin-off announcements are go with by increases in share prices and that share prices of highly diversified or unprofitable companies showed the most dramatic increases. In corporate spin offs is take advantage of tax benefits. Some of benefits is getting by companies in spin offs such as abnormal returns, ex-day puzzle, tax incentives, information benefits. The main effect of corporate spin offs is to enjoy the cost of combined units. In equity carve outs I conclude that the companies are adopt the method of equity carve outs to motivation for parent firm and sources of value creation. In equity carve out I identified that equity carve out are highly differentiate from other methods of corporate restructuring. Equity carve outs is also a way of reducing their exposure to a riskier line of firm and to boost shareholders value. In equity carve outs A new legal entity is created, and A new control group is immediately created. Every one carved-out subsidiary has its own board, operating CEO, and financial statements, while the parent provides strategic direction and central resources. In divestments I conclude that company is adopted the divestments method to increase the markets share, availability of better alternatives for company and the need for increased investment. Some of other condition involved as lake of strategic fit, some of legal pressure to divestments. I conclude that among the various methods of divestiture, the most important ones are partial sell-off; demerger (spin-off & split off) and equity carve out. I conclude some of motives for divestment as Change of focus or corporate strategy, Unit unprofitable can mistake, Defend against takeover, good price and need for cash. In share repurchase in conclude that some off outcome of share repurchase in firm such as increase in confidence in management, enhances share holder value, higher share price, increase ROE. Share repurchase allows a company to pass on extra cash to shareholders without raising the dividend. Some of other effects as Stock buybacks also raise the demand for the stock on the open market, tax implication and excellent tool for financial reengineering. I conclude that some circumstances in which the company is adopted the method of share repurchase are firm had big quantity of unused cash and some objectives as, market perception, exit option, increase promotion stake and show better financial ratios. In share repurchase some of other relevance is discussed. In corporate recovery I have trying covered every possible option for corporate recovery. In research of corporate recovery it concludes that the company to adopt the process of corporate recovery need to expert management for the purpose of consultation. I conclude that if the company used the method of corporate recovery is saved the risk of insolvency. The company is bearing some of professional team cost in process of corporate recovery. Corporation is used some of corporate recovery strategies for implementing the process of corporate recovery.
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References
Lovett, David, (2004).”Corporate recovery” penguin published group. Ragan Das, Udayan Kumair, (2004).“Corporate restructuring enhancing share holder value” Hill publishing company. Vermaelen, Theo, (2005) “Share Repurchases” Now publisher INC. Nazim-ud-din, (2008) addition. “Advanced financial accounting and analysis” Whaeed publications. Abor, J. (2005). The effect of capital structure on profitability: an empirical analysis of listed firms in Ghana. The Journal of Risk Finance, 6(5), 438-445. Allan, C. A. L. (2004). The impact of corporate governance practices on firms’ financial performance. Asean Economic Bulletin, 21(3), 308-138. Anthony, K. C. (2007). The impact of capital structure on the performance of microfinance institutions. The Journal of Risk Finance, 8(1), 56-71. Fortune 2003, “Global 500: The World’s Largest Corporations,” Fortune, July 21: F1F43. Lazonick, William. (2003).”Corporate Restructuring” The Oxford Handbook of Work and Organization. Pomerleano Michael, Shaw William, (2005).”Corporate restructuring” Lesson from experience. Chandler, A., 1990, Scale and Scope: The Dynamics of Industrial Capitalism, Harvard University Press. Best, M., 2001, The New Competitive Advantage: The Renewal of American Industry, Oxford University Press. Nag, G.C.Pathak(2009).”a boon for competitive advantage”. Advances accounting publisher. Pearson, Michael. "Spin-offs: Breaking up Is Hard to Do." Journal of Business Strategy, July-August 1998, 31. Sadtler, David, (1997).”Breakup” New York: The Free Press.
Chemmanur, Thomas, (2003).”A theory of corporate spin-offs” Journal of Financial Economics
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Carey, Dennis,( 1997).” Structure” Journal of corporate finance Weisbenner, Scott J,( 1998).” Corporate Share Repurchases in the 1990s” Federal Reserve Board Elliott, David, (2007). “Corporate recovery” Abardanell, J., Bushee, B. & Raedy, J. 2003. Institutional investor preferences and price pressures: the case of corporate spin-offs. Journal of Business, 76(2): 233-261 Allen, J. 2001. Private information and spin-off performance. Journal of Business, 74(2): 281Cusatis, P.; Miles, J.; Woodridge, J.R.: “Some new Evidence that Corporate Spin-Offs Create Value”, Journal of Applied Corporate Finance, 7, 1994, p.100-107 Aron, D., 1991. Using the capital market as a monitor: Corporate spin-offs in an agency framework. Rand Journal of Economics 22, 505-518.
Websites www.investopedia.com http://www.caclubindia.com/articles/types-of-corporate-restructuring-5649.asp http://www.thinkingmanagers.com/business-management/corporate-restructuring.php http://www.corporate-spin-offs.com/ http://www.ehow.com/list_6519633_forms-corporate-restructuring.html http://www.indianmba.com/Faculty_Column/FC699/fc699.html
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Words count Chapter 1 ……………………..2466 Chapter 2 .…………………….963 Chapter 3 …………………… 4017 Chapter 4 ……………………..1772 Chapter 5 .……………………..1128 Chapter 6 .……………………….3292 Chapter 7 .……………………..1522 Chapter 8 .……………………..1647 Chapter 9……………………….992 ----------------Total words …………………..17,800 -----------------
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