corporate restructuring through transitory joint ventures .2009-05-07 · corporate restructuring
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CORPORATE RESTRUCTURINGTHROUGH TRANSITORY JOINT VENTURES
P. J. WILLIAMSON**
* Assistant Professor, at Harvard Business School.
** Visiting Professor of International Management at INSEAD Euro-Asia Centre, Boulevard deConstance, 77305 Fontainebleau Cedex, France.
A working paper in the INSEAD Working Paper Series is intended as a means whereby a faculty researcher'sthoughts and findings may be communicated to interested readers. The paper should be consideredpreliminary in nature and may require revision.
Printed at INSEAD, Fontainebleau, France.
CORPORATE RESTRUCTURING THROUGHTRANSITORY JOINT VENTURES
Ashish Nanda & Peter J. Williamson
Ashish NandaAssistant ProfessorHarvard Business School
Peter J. WilliamsonVisiting Professor of International ManagementINSEAD Euro-Asia Centre
We are grateful to R.E. Caves, G. Ellison, 0. Hart, and F.M. Scherer for theirsuggestions, to C.A. Bartlett for his contribution to the Corning case studythat triggered our thoughts on this subject, to K. Ryan and M.I. Stevenson fortheir assistance in information retrieval, and to participants in the HarvardUniversity seminars for their comments. We are thankful to the Harvard BusinessSchool Division of Research for financial support.
This paper proposes that joint ventures can be used as transitory organizations that aid inthe process of corporate restructuring. If the quality of a business is not observable by an outsider,then a firm that is trying to sell the business faces the problem of adverse selection. A game-theoretic model is used to show that this problem can be alleviated if the restructurer converts thebusiness into a transitory joint venture with the potential buyer. Transitory joint venturing is theoptimal way to achieve corporate restructuring if joint venture administrative cost is moderately highand if a large proportion of businesses that are up for sale are of low quality. Case studies ofcorporate restructuring through transitory joint ventures are used to illustrate and extend thesearguments.
Diversified corporations often restructure their portfolio by selling 'non-core' businesses.Empirical studies have suggested that this process of corporate 'refocusing' has been gatheringpace during the 1980s (Williams, Paez, and Sanders, 1988; Markides, 1990; Lictenberg, 1992).Several firms have divested business units they had aggressively acquired during the late 1960sand early 1970s (Ravenscraft and Scherer, 1987; Kaplan and Weisbach, 1992), and suchrestructuring has been value-enhancing in general (Lichtenberg, 1992; Markides, 1992).
Value creation through restructuring is feasible if there are other firms that possessresources and 'organizational routines' (Nelson and Winter, 1982) which are complementary to thebusiness the restructurer wants to divest. The complementary resources may be 'tacit' (e.g.technical know-how, market knowledge: see Polanyi, 1967); the routines may manifest themselvesin untradeable organizational characteristics such as management style and operationalphilosophy. If these resources and routines were to be applied to the business, its profitabilitywould rise. We call these resources and 'routines' collectively as competencies. Thesecompetencies can be so inalienably intertwined with the rest of the organization that it is impossibleto disentangle them in order to replicate or transfer them as discrete assets.
In analyzing this problem of collocating a business with complementary competencies thatare non-marketable as discrete assets, we make the reasonable assumption that it is uneconomicfor the entire firm owning the business to merge with the entire firm owning complementarycompetencies. The firms may be involved in several unrelated businesses; their administrativemechanisms and corporate cultures may be very different, leading to diseconomies if the two firmswere to merge. Frequently, therefore, the only way for a business to collocate with its complemen-tary competencies in such a circumstance would be for the firm that owns the business to sell it tothe firm that owns the competencies.
Such restructuring transactions often confront the problem of adverse selection. Typically,a significant fraction of the value of the business that is being sold comprises externally non-monitorable competencies, e.g. a research staff's technical knowledge, manufacturing systems forensuring production quality, worker morale, etc. In this case, it is impossible for the business's"quality' to be observed by an outsider. This leads to all types of restructurers projecting theirbusinesses as being of high quality, irrespective of the reality, causing the familiar 'lemons' problem(Akerlof, 1970): if direct sale is the only option and most businesses are of low quality, then ownersof high quality businesses are shut out of the market. In this paper, we show how and when jointventures can offer firms a way out of this restructuring impasse.
At first blush, joint ventures seem to be singularly unsuited organizational arrangements foraccomplishing efficient outcomes. Organization theorists (e.g. Hart and Moore, 1990) havereasoned that joint ventures are sub-optimal organizations, since achieving decisions that satisfymultiple owners is costly. In this paper, we argue that, precisely because joint venturing is a costlyorganizational arrangement, a restructurer can credibly demonstrate the quality of its business toa potential buyer by converting it into a joint venture. Further, because joint venturing is costly,once the business and the complementary competencies are collocated and the quality of thebusiness is unveiled to the partner, it is optimal for both parties that the joint venture be unwound.The incoming party buys out the restructurer's share in the joint venture. Hence, through use of
transitory joint ventures, firms can effectively accomplish value-enhancing corporate restructuringwhich would otherwise have been thwarted by adverse selection.
Take the example of the Dutch electronics multinational, Philips. When Philips sought toreorganize its diverse portfolio in the late-1980s, it identified the $1.55 billion major domesticappliances division as "non-core." The division had a history of poor financial performance, neededa huge capital injection to update its manufacturing facilities, and was operating with 14,000employees, many of whom were protected by-European legislation on job security. Despite theobvious problems that the appliances division faced, Philips management knew that it had valuableassets: pockets of underutilized manufacturing skills within its patchy string of 10 plants spreadacross five countries, as well as a portfolio of some of Europe's best-known brands, designexpertise, and a pan-European dealer network that together placed it number two in market sharebehind Electrolux.
Whirlpool of U.S. was an obvious potential buyer. Whirlpool management were looking toexpand overseas. They appreciated the benefits of inheriting a major European position in anindustry that was rapidly becoming global. They also sensed that if they introduced practices suchas global components sourcing, transferred advanced manufacturing processes, and introducedtheir state-of-the-art designs, then they could radically alter the profitability of the business.However, unsure about the potential of the appliances business, they valued it about 25% less thanwhat Philips's management were willing to accept.
A joint venture provided the solution to this deadlock. In 1989, Philips sold 53% share ofits appliances SBU to Whirlpool, allowing the business to access Whirlpool's complementarycompetencies. Simultaneously, Whirlpool was able to assess the true value of Philips' customerfranchise and manufacturing facilities as an "insider."
From the outset, both partners regarded the joint venture as transitory: Whirlpool had theoption to buy out Philips' 47% stake within three years of entering the joint venture. In fact,Whirlpool did exercise this option in 1991, and Philips exited the business on substantially morefavorable terms the uplift was estimated at $270 million than if it had simply sold the businessthree years before.
Novel though the arrangement was, it wasn't unique. Although joint ventures havetraditionally been viewed purely as an option for expanding into new businesses, today corporationsare increasingly using joint ventures as restructuring tools. This paper identifies the circumstancesin which instances such as the above firms employing joint ventures to restructure theiroperations offer a value-creating mechanism. The rest of the paper is organized as follows.
Section II describes the model's technological and contractual assumptions. Joint venturingis offered as an aftemate mechanism to direct sale for bringing together a business owned by oneparty with complementary competencies owned by another party.
Section III solves the model described in section II. It shows why restructuring joint venturesthat are transitory by design can act as efficient organizational mechanisms for signaling businessquality. If joint venture administrative cost is moderately high and a large proportion of existingbusinesses are of low quality, then the owner of a high quality business converts it into a joint
venture with the potential buyer, whereas the owner of a low quality business directly sells itsbusiness.
Section IV discusses the special case in which complementary competencies can increasethe profitability of a low quality business much more than they increase the profitability of a highquality business. In such a case, joint venturing is used to signal low quality: if the additionala