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Corporate Restructuring and Investment Horizons in the United States, 1976–1987

Published online by Cambridge University Press:  13 December 2011

Bronwyn H. Hall
Bronwyn H. Hall
Affiliation:
Bronwyn H. Hall is associate professor of economics at theUniversity of California, Berkeley, and a research associate at the National Bureau of Economic Research in Stanford, California.
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Many observers of the corporate restructurings that reached major proportions in the United States in the 1980s have believed that the market for corporate control had a serious negative impact on companies' long-term investment, which in turn contributed to the United States's decline in global competitiveness. In the following study, the author looks carefully at the effects of financial restructurings on investment, especially at expenditures on R&D, in a large set of companies categorized according to their level of technology and the length of their investment horizon. She then compares the U.S. situation with that in the United Kingdom, Germany, and Japan. She concludes that, though many such events occasioned no change at all in investment strategies, restructuring pressures and declines in investment tended to concentrate in certain industries. She also finds that investment decisions were usually rational, given high interest rates and a tax environment that favored debt over equity.

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Articles
Information
Business History Review , Volume 68 , Issue 1: Competitiveness and Capital Investment: The Restructuring of U.S. Industry, 1960–1990 , Spring 1994 , pp. 110 - 143
Copyright
Copyright © The President and Fellows of Harvard College 1994

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References

1 For evidence that acquisition and divestiture of lines of business during the 1980s was motivated to a great extent by the undoing of the conglomerate wave of the 1960s and 1970s (and was accompanied by productivity gains in the core line of business), see Bhagat, Sanjai, Shleifer, Andrei, and Vishny, Robert, “Hostile Takeovers in the 1980s: The Return to Corporate Specialization,” Brookings Papers on Economic Activity: Microeconomics 1990 (Washington, D.C., 1990), 1–72Google Scholar, and Frank R. Lichtenberg, “Industrial De-diversification and Its Consequences for Productivity,” NBER Working Paper no. 3231 (1990).

2 See Jarrell, Gregg A., Lehn, Ken, and Marr, Wayne, “Institutional Ownership, Tender Offers, and Long-Term Investments,” Securities and Exchange Commission (Washington, D.C., April 1985)Google Scholar; Hall, Bronwyn H., “The Effect of Takeover Activity on Corporate Research and Development,” in Corporate Takeovers: Causes and Consequences, ed. Auerbach, Alan J. (Chicago, Ill., 1988): 69–100Google Scholar, and Hall, , “The Impact of Corporate Restructuring on Industrial Research and Development,” Brookings Papers on Economic Activity: Microeconomics 1990 (Washington, D.C., 1990), 85–135Google Scholar, and Meulbroek, Lisa K., et al. , “Shark Repellents and Managerial Myopia: An Empirical Test,” Journal of Political Economy 98 (Oct. 1990): 1108–17CrossRefGoogle Scholar, all of whom use R&D as a proxy for long-term investment.

3 See Pakes, Ariel and Schankerman, Mark, “The Rate of Obsolescence of Patents, Research Gestation Lags, and the Private Rate of Return to Research Resources,” in R&D, Patents, and Productivity, ed. Griliches, Zvi (Chicago, Ill., 1984), 73–88Google Scholar, and Hall, Bronwyn H., “The Value of Intangible Corporate Assets: An Empirical Study of Tobin's Q,” unpub. MS, NBER and University of California, Berkeley, 1988.Google Scholar

4 When the production of capital from investment is additively separable, as is usually assumed for ordinary investment, a high depreciation rate implies a quick payback on investment, and vice versa. But if the production of knowledge capital from R&D investment is not additively separable, as seems likely, it is possible to show that a depreciation rate that is measured as high when a conventional perpetual inventory specification is used is consistent with very slowly decaying rates of return to lagged R&D expenditures.

5 Bernstein, Jeffrey I. and Nadiri, M. Ishaq, “Research and Development and Intra-Industry Spillovers: An Empirical Application of Dynamic Duality,” Review of Economic Studies 56 (April 1989): 249–69CrossRefGoogle Scholar; Bernstein, and Nadiri, , “The Effect of Direct and Indirect Tax Incentives on Canadian Industrial R&D Expenditures,” Canadian Public Policy 12 (1986): 438–48CrossRefGoogle Scholar; and Hall, Bronwyn, Hausman, Jerry A., and Griliches, Zvi, “Patents and R&D: Is There a Lag?” International Economic Review 27 (1986): 265–83.CrossRefGoogle Scholar

6 Bhagat, Shleifer, and Vishny, “Hostile Takeovers in the 1980s.”

7 For the former, see Hall, “Effect of Takeover Activity”; Hall, “Impact of Corporate Restructuring”; Lichtenberg, Frank R. and Siegel, Donald, “The Effects of Leveraged Buyouts on Productivity and Related Aspects of Firm Behavior,” Journal of Financial Economics 27 (1990): 165–94CrossRefGoogle Scholar; Lichtenberg, and Siegel, , “The Effect of Ownership Changes on the Employment and Wages of Central-Office and Other Personnel,” Journal of Law and Economics 33 (1990): 383–408CrossRefGoogle Scholar; and Smith, Abbie, “Corporate Ownership Structure and Performance: The Case of Management Buyouts,” Journal of Financial Economics 27 (1990): 143–64.CrossRefGoogle Scholar For the latter, see Miller, Robert R., “Do Mergers and Acquisitions Hurt R&D?” Research-Technology Management 33 (March-April 1990): 11–15CrossRefGoogle Scholar; Miller, “Effect of Restructuring on Technology Development,” paper presented at the NAE Workshop on Financial and Managerial Impacts on Corporate Time Horizons; and Fusfeld, Herbert I., “Corporate Restructuring—What Impact on U.S. Industrial Research?” Research Management 30 (July-Aug. 1987): 10–17.CrossRefGoogle Scholar

8 Hall, “Impact of Corporate Restructuring.”

9 Kaplan, Steven N., “Management Buyouts: Evidence on Post-Buyout Operating Changes,” unpub. MS, University of Chicago Business School, 1989Google Scholar; and Lichtenberg and Siegel, “Effects of Leveraged Buyouts on Productivity.”

10 Lichtenberg and Siegel, “Effects of Leveraged Buyouts on Productivity.”

11 Kaplan, Steven N., “Management Buyouts: Evidence on Taxes as a Source of Value,” Journal of Finance 44 (1989): 611–32CrossRefGoogle Scholar; Kaplan, “Management Buyouts: Evidence on Post-Buyout Operating Changes”; and Smith, “Corporate Ownership Structure and Performance.”

12 The result cited is not actually in the Kaplan papers, which I reference because they describe the data on which the result is based. It was communicated to me privately by Steven Kaplan; it is a measure of the unimportance of R&D in the large-scale MBO sample that he did not mention it in print.

13 To my knowledge, mine was the only research available at the time this article was written (early 1991), except for a few case studies, that looked at large financial restructurings unaccompanied by a change of control.

14 Lichtenberg and Siegel, “Effect of Ownership Changes.”

15 Paul M. Healy, Krishna G. Palepu, and Richard S. Ruback, “Does Corporate Performance Improve after Mergers?” NBER Working Paper no. 3348, 1990.

16 Bhagat, Schleifer, and Vishny, “Hostile Takeovers in the 1980s.”

17 Chandler, Alfred D. Jr., “The Competitive Performance of U.S. Industrial Enterprises since the Second World War,” Business History Review 68 (Spring 1994): 1–72.CrossRefGoogle Scholar

18 See Hall, Bronwyn H., “The Manufacturing Sector Master File: 1959–1987,” NBER Working Paper no. 3366, Cambridge, Mass. (1990)CrossRefGoogle Scholar, for more detail on data construction. The LBO sample consists primarily of those firms specifically identified by Kaplan, “Management Buyouts: Evidence on Taxes,” and Kaplan, “Management Buyouts: Evidence on Post-Buyout Operating Changes,” or Lehn, Kenneth and Poulsen, Annette B., “Free Cash Flow and Stockholder Gains in Going Private Transactions,” Journal of Finance 44 (1989): 771–87, as leveraged buyouts.CrossRefGoogle Scholar

19 Although the regressions could just as well be measuring increases in investment following declines in long-term debt, the results will in fact be dominated by the consequences of increased debt, since 80 percent of these firms experienced an increase in debt in any given year. I checked the result by estimating the regression with separate coefficients for increases and decreases in long-term debt, and found that the two coefficients were insignificantly different from each other, although the coefficient for investment changes following increases in debt was slightly larger in absolute value.

20 My primary sources for this evidence are Miller, “Do Mergers and Acquisitions Hurt R&D?” and “Effect of Restructuring on Technology Development,” and Fusfeld, “Corporate Restructuring,” plus testimony at a July 1989 hearing of the Science, Research, and Technology Subcommittee of the House Committee on Science, Space, and Technology.

21 See Jacobs, Allan E., “The Agency Cost of Corporate Control: The Petroleum Industry,” unpub. MS, Massachusetts Institute of Technology (1986).Google Scholar

22 Note that the case-study evidence ignores a few industries, in particular food and textiles, where substantial restructurings have occurred. These industries engaged in comparatively little investment in R&D, which was the focus of the evidence being collected. Even with a focus on R&D-performing firms, however, the case studies are dominated by firms in medium- or stable-technology, not high-technology, industries.

23 Kaplan, “Management Buyouts: Evidence on Taxes”; Kaplan, “Management Buyouts: Evidence on Post-Buyout Operating Changes”; and Smith, “Corporate Ownership Structure and Performance.”

24 Ashmore, David, “Examining the Effects of Takeover Pressure on Research and Development Intensity” (Senior Honors Thesis, Department of Economics, Harvard University, 1990).Google Scholar

25 Stein, Jeremy C., “Takeover Threats and Managerial Myopia,” Journal of Political Economy 96 (Feb. 1988): 61–80CrossRefGoogle Scholar; Meulbroek, et al., “Shark Repellents and Managerial Myopia.”

26 See my results on mergers in Hall, “The Effect of Takeover Activity,” and in Hall, Bronwyn H., “Research and Development at the Firm Level: Does the Source of Financing Matter?” unpub. MS, Berkeley, Calif., 1990Google Scholar; Lichtenberg and Siegel on ownership changes; and Bhagat, Shleifer, and Vishny on hostile takeovers.

27 In the case of the petroleum-refining industry, there is another factor: much of the R&D investment is related to the exploration and development of oil reserves rather than to manufacturing activities. There is some reason to think of this as a special case driven by the expectations of future world oil prices; we may believe that the social return (at a national level) to this type of investment is higher than the private return, but not necessarily for the same reasons as hold for the rest of the manufacturing sector. See Jensen, Michael, “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers,” American Economic Review 76 (1986): 323–29.Google Scholar

28 Blair, Margaret Mendenhall, “A Surprising Culprit Behind the Rush to Leverage,” The Brookings Review 8 (Winter 1989–1990): 19–26CrossRefGoogle Scholar; Blair, and Litan, Robert E., “Corporate Leverage and Leveraged Buyouts in the Eighties,” in Debt, Taxes, and Corporate Restructuring, ed. Shoven, John B. and Waldfogel, Joel (Washington, D.C., 1990), 43–99.Google Scholar

29 See Schipper, Katherine and Smith, Abbie, “Effects of Management Buyouts on Corporate Interest and Depreciation Tax Deductions,” Journal of Law and Economics 34 (Oct. 1991): 293–341CrossRefGoogle Scholar; and Scholes, Myron S. and Wolfson, Mark A., “The Effects of Changes in Tax Laws on Corporate Reorganization Activity,” Journal of Business 63 (Jan. 1990): S141–64CrossRefGoogle Scholar, for a discussion of the changes in relative tax rates on debt and equity in the 1981 and 1986 Tax Reform Acts and of their effect on leveraged buyout activity.

30 See Robert N. McCauley and Steven A. Zimmer, “Explaining International Differences in the Cost of Capital: The United States and United Kingdom versus Japan and Germany,” Federal Reserve Bank of New York Research Paper no. 8913 (1989), for a more detailed discussion of the impact of the cost of capital on long-term investments.

31 Blair and Litan, “Corporate Leverage and Leveraged Buyouts in the Eighties.”

32 A major study of this question by Margaret Blair and Martha Schary was published after this article was written. See Blair and Schary, “Industry-Level Indicators of Free Cash Flow,” and “Industry-Level Pressures to Restructure,” in The Deal Decade: What Takeovers and Leveraged Buyouts Mean for Corporate Governance, ed. Blair, Margaret M. (Washington, D.C., 1993), 99–135, 149–90.Google Scholar

33 Froot, Kenneth A., Perold, André F., and Stein, Jeremy C., “Shareholder Trading Practices and Corporate Investment Horizons,” Journal of Applied Corporate Finance 5 (Summer 1992): 42–58CrossRefGoogle Scholar; Hall, “Impact of Corporate Restructuring.”

34 Woolridge, J. Randall, “Competitive Decline and Corporate Restructuring: Is a Myopic Stock Market to Blame?” Journal of Applied Corporate Finance 1 (Spring 1988): 26–36.CrossRefGoogle Scholar

35 In this connection, see the recent paper by Duncan Foley and William Lazonick, “Corporate Takeovers and the Growth of Productivity,” Working Paper no. 91-01, Barnard College, Department of Economics (1990), which uses an endogenous growth model (a model where innovation spills over to other firms) together with market mispricing of innovative firms to show that lower takeover costs can lead to an equilibrium growth rate for labor productivity that is lower than the one that would be associated with higher takeover costs.

36 But see the discussion in Hall, “The Impact of Corporate Restructuring,” which cites Griliches, Zvi, “Market Value, R&D, and Patents,” Economic Letters 7 (1981): 183–87CrossRefGoogle Scholar, Iain Cockburn and Griliches, “Industry Effects and Appropriability Measures in the Stock Market's Valuation of R&D and Patents,” NBER Working Paper no. 2465 (1987), Hall, “The Value of Intangible Corporate Assets,” Jarrell, Lehn, and Marr, “Institutional Ownership,” and Woolridge, “Competitive Decline and Corporate Restructuring,” for evidence that the stock market, at least, appears to value R&D investments positively.

37 Hirschman, Albert O., Exit, Voice, and Loyalty: Responses to Decline of Firms, Organizations, and States (Cambridge, Mass., 1970).Google Scholar

38 The evidence for this distinction is in Edwards, J. S. S. and Fischer, Klaus, “Banks, Finance and Investment in West Germany since 1970,” Working Paper no. 497, CEPR, London (1991)Google Scholar; Edwards, Franklin R. and Eisenbeis, Robert A., “Financial Institutions and Corporate Investment Horizons: An International Perspective,” unpub. MS (1991)Google Scholar; Franks, Julian and Mayer, Colin, “Capital Markets and Corporate Control: A Study of France, Germany, and the UK,” Economic Policy 10 (April 1990): 189–232CrossRefGoogle Scholar; Kester, W. Carl, “Governance, Contracting, and Investment Horizons: A Look at Japan and Germany,” Journal of Applied Corporate Finance 5 (Summer 1992): 83–98CrossRefGoogle Scholar; Mayer, Colin and Alexander, Ian, “Banks and Securities Markets: Corporate Financing in Germany and the U.K.,” Working Paper no. 433, CEPR, London (1990Google Scholar), and Takeo Hoshi, Anil Kashyap, and David Scharfstein, “The Role of Banks in Reducing the Costs of Financial Distress in Japan,” NBER, Working Paper no. 3435 (1990).

39 The United Kingdom has experienced the same explosive growth in LBO activity as the United States, with the total annual value of transactions rising from less than £100 million before 1980 to £3.7 billion in 1988. This tremendous growth has been achieved with a somewhat lower use of debt than in the United States.

40 Franks and Mayer, “Capital Markets and Corporate Control: A Study of France, Germany, and the UK.” On Japan, see Hodder, James E., “Corporate Capital Structure in the U.S. and Japan: Financial Intermediation and Implications of Financial Deregulation,” unpub. MS, Stanford University (1985)Google Scholar; and Hoshi, Kashyap, and Scharfstein, “The Role of Banks.”

41 Franks and Mayer, “Capital Markets and Corporate Control: A Study of France, Germany, and the UK,” 213.

42 Hoshi, Takeo, Kashyap, Anil, and Seharfstein, David, “Bank Monitoring and Investment: Evidence from the Changing Structure of Japanese Corporate Banking Relationships,” unpub. MS, NBER (1990Google Scholar), and Hoshi, Kashyap, and Scharfstein, “The Role of Banks.”

43 Edwards and Fischer, “Banks, Finance, and Investment in West Germany.”

44 Mayer, Colin, “Financial Systems, Corporate Finance, and Economic Development,” in Asymmetric Information, Capital Markets, and Investment, ed. Hubbard, G. (Chicago, Ill., 1990), Table 12.1, pp. 307–32.Google Scholar I have reproduced some of these figures in my Table 5, along with some of my own for U.S. and Japanese manufacturing. Net financing is shown as a proportion of capital expenditures and stock building.

45 Mayer and Alexander, “Banks and Securities Markets.”

46 Edwards and Fischer, “Banks, Finance, and Investment in West Germany.”

47 Hall, Bronwyn H., “Research and Development Investment at the Firm Level: Does the Source of Financing Matter?” unpub. MS, University of California, Berkeley, and ENSAE-CREST (1991)Google Scholar; Stephen Bond and Costas Meghir, “Dynamic Investment Models and the Firm's Financial Policy,” Working Paper no. W90/17, Institute for Fiscal Studies, London (1990).

48 Another piece of evidence on this question is the payout ratio, the fraction of zero-dividend operating income paid out as dividends. Mayer and Alexander, “Banks and Securities Markets,” report that this number averages 13 percent for large German non-financial corporations and 31 percent for the United Kingdom. In my U.S. sample, the number is almost exactly the same as that for Germany.

49 Ibid.

50 One institutional change that has some merit is a relaxation of the restrictions on shareholding by banks. See Edwards and Eisenbeis, “Financial Institutions and Corporate Investment Horizons.”

51 Kester, “Governance, Contracting, and Investment Horizons”; Hoshi, Kashyap, and Scharfstein, “Bank Monitoring and Investment”; and Hodder, “Corporate Capital Structure in the U.S. and Japan.”

52 Compare the conclusions in Franks and Mayer, “Capital Markets and Corporate Control: A Study of France, Germany, and the UK,” with those in Edwards and Fischer, “Banks, Finance, and Investment in West Germany” (concerning the role of banks in Germany); on Japan, see the two papers by Hoshi, Kashyap, and Scharfstein.