Research Wire

DOES DOWNSIZING IMPROVE PERFORMANCE?

Corporate restructuring has become a staple of management life. But when is it most likely to improve a company’s financial performance?

A recent Wharton study categorized restructuring into three types: financial restructuring (changing the capital structure of the firm including leveraged buyouts, leveraged recapitalizations and debt for equity swaps); portfolio restructuring (significant changes in the mix of assets); and organizational restructuring (employee layoffs). Financial restructuring, the study concluded, has the most positive impact on performance, followed by business portfolio restructuring. Organizational restructuring such as downsizing, has little, if any, impact. The research, conducted by a team of management professors, was based on an analysis of 52 studies of corporate restructuring and its financial performance implications.

Edward H. Bowman, Harbir Singh, Michael Useem and Raja Bhadury; When Does Restructuring Work?

INEFFECTIVE CORPORATE GOVERNANCE LINKED TO HIGH CEO PAY AND POOR PERFORMANCE

There is a growing debate in business and academia over whether U.S. boards of directors are effective, and in particular, whether they structure CEO pay packages that maximize shareholder value. A new Wharton study examines whether variations in the effectiveness of corporate governance structures lead to variations in CEO pay levels. The authors find that certain board and ownership structures appear to enable CEOs to exercise their influence over the board in order to obtain compensation in excess of the level implied by firm size, performance and industry membership. And, that the excess compensation earned by these CEOs is a sign of other weaknesses in the firm’s governance mechanisms that lead to worse subsequent accounting and stock market performance. The authors find that corporate governance is weaker when the CEO is also the chairman, the board is larger, the outside directors are less independent (as measured by the number of outside directors who were appointed by the CEO), directors receive fees in excess of their board pay, or directors are interlocked. In addition, corporate governance is weaker when outside directors are less able to attend to their duties (as measured by the number of outside directors who are over age 69 or who serve on three or more other boards).

Corporate governance is stronger when the CEO owns more stock and when there is another insider or outsider who owns 5 percent of the firm.

The authors do not find evidence to support the common contentions that there should be more outside directors on the board and that outside directors should own more stock.

John E. Core, Robert W. Holthausen and David F. Larcker; Corporate Governance, CEO Compensation and Firm Performance

ON THE VERGE OF RETIREMENT: FINANCIAL POSITION MAY BE BETTER THAN EXPECTED

As debate rages around social security reform, many have worried that current generations of workers are in for tough financial times during retirement. But according to a new study from Wharton’s Pension Research Council, Americans on the verge of retirement today may, in fact, be better off than commonly believed. A team of researchers analyzed data from the Health and Retirement Study (HRS), a new nationally representative survey that measured income and wealth for Americans age 51 to 61 in 1992. They valued expected pension and social security benefits and computed expected retirement wealth relative to pre-retirement income. They found that pensions, social security, and retiree health insurance together account for 60 percent of the wealth anticipated by the median HRS household, and for 48 percent of wealth for the wealthiest group of Americans.

“To be sure, we recognize that many people enter retirement with inadequate assets,” the authors write. “And of course, many people are heavily dependent on social security … But on the whole, the population entering retirement may not be in as bad shape as some have led us to believe.” On the other hand, warns Olivia Mitchell, a Wharton professor and an author of the study, “having more wealth than the abysmally low levels reported by the media is probably not enough for a comfortable lifestyle during the golden years.”

Olivia Mitchell, Alan Gustman, Andrew Samwick and Thomas Steinmeier; Pension and Social Security Wealth in the Health and Retirement Study

HOW TO REFORM THE JAPANESE FINANCIAL SYSTEM

During the 1980s the Japanese financial system was widely regarded as a model to be emulated around the world. The strength of Japanese firms in international markets was at least partially attributed to its financial system. Japan had one of the highest savings rates in the world and ultimately these funds were transformed into effective investments by Japanese firms. Banks tended to invest for the long term and they developed close relationships with the companies in which they invested. As recent history has all too clearly demonstrated, however, this system has developed some cracks. In a recent paper assessing the strengths and weaknesses of the Japanese financial system, Finance Professor Franklin Allen suggests several reforms including:

-Limit the amount of debt that can be used in financing investment in real estate and limit implicit and explicit government guarantees of real estate investments.

-Encourage the development of a competitive mutual fund industry to more widely disperse and reduce the fragility of the banking system.

-Do not allow a market for corporate control, but try to strengthen internal governance mechanisms. One possibility is to increase limitations on the proportions of equity that banks and insurance companies can hold in a single company.

-Reform the postal savings system by reducing tax and other advantages.

-Encourage the development of a significant venture capital sector by creating tax advantages.

Franklin Allen; The Future of the Japanese Financial System

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