Five Questions for Stuart Gilson

by Sean Silverthorne

Harvard Business School professor Stuart Gilson fielded some questions regarding his new book in an email interview with HBS Working Knowledge editor Sean Silverthorne

Silverthorne: When should a company consider a major restructuring? Are there tell-tale signs?

Gilson: I define corporate restructuring as the process through which a company radically changes the contractual relationships that exist among its creditors, shareholders, employees, and other stakeholders. The goal of restructuring is to increase the overall market value of the business enterprise. Often the "value gap" that restructuring addresses is very large—in the billions of dollars possibly. My research at companies suggests there are three primary motivations for restructuring.

The first is the need to address poor financial performance. Here, the warning signs are usually pretty clear: declining or stagnating sales, accounting losses, or a falling stock price. In extreme cases such poor performance may cause the company to default on its debt, resulting in bankruptcy. Restructuring the debt can be difficult and costly, although in some cases legal strategies are available that can greatly accelerate the process. In the U.S., bankruptcy can also be used to revitalize the business—for example, by allowing companies to reject unfavorable leases, or sell unwanted assets in a competitive auction.

The second reason to restructure is to support a new corporate strategy, or to take advantage of a business opportunity. For example, in an equity spin-off, a diversified firm's businesses are split apart into independent entities, each with its own common stock. Spin-offs can make sense when a high-growth business is being held back by a bureaucratic corporate parent, or when it no longer makes sense for a company to be vertically integrated. Here, one sign that restructuring may be necessary is evidence that the stock market is valuing the entire company for less than its separate businesses would be valued if they were separate, independently-traded companies. (In other words, 2 + 2 = 3) To make this diagnosis, one obviously has to make all kinds of assumptions, but sometimes the implied value gap is just enormous.

The third reason companies restructure is to correct a large error in how the company is valued in the capital market. This problem, like the previous one, is especially prevalent for large diversified companies that operate in many different businesses. Financial analysts and investors may have an especially difficult time understanding what's going on in these companies, or may lack the industry expertise to assess the business prospects of all the company's operations. Even though each of the businesses may be well-run, investors may place too low a value on the overall portfolio. Restructuring tools like tracking stock, stock buybacks, or leverage buyouts, can be used to reduce this kind of value gap.

Q: You suggest that some companies could benefit by restructuring before they are hit with a financial crisis. When is a preemptive restructuring appropriate?

A: If a company waits too long to address problems with its business, the resulting restructuring may be very painful. This may deter executives from taking the full measures that are necessary to return the business to a sound footing. Or the resulting restructuring may severely disrupt the business. If it is necessary to layoff 20 percent of your workforce to achieve the same cost efficiency as your competitors, better to do this over several years than all at once—but the key is to recognize the problem as early as possible. This is why I recommend that companies do a "restructuring audit" on their businesses periodically, looking for opportunities to create value by voluntarily restructuring, before circumstances leave them with no choice.

Q: Which company in your mind executed the most successful restructuring, and which company the worst?

A: This is a hard one to answer, because the restructurings that I analyzed were intended to address a variety of different problems and challenges, and entailed a range of methods and approaches. I also deliberately sought out companies that managed the restructuring process successfully, despite facing huge obstacles, to highlight "best practice" (although in several cases I did not know what the outcome would be when I first contacted the companies.) Some of my choices for the most successful restructurings would strike many people as controversial. One would be the downsizing of Scott Paper Company under "Chainsaw" Al Dunlap, in which the company eliminated approximately a third of its workforce. Another would be the employee buyout of United Air Lines, in which the airline's pilots and machinists were given a majority of the company's stock in exchange for almost $5 billion in wage and benefit concessions. The two cases are fascinating contrasts. Scott Paper's restructuring involved large-scale job reductions, while United's gave employees job security (and even some control over the business). Despite how Scott's restructuring was often portrayed in the news media, however, the treatment of the affected workers was by and large pretty humane. Moreover, Dunlap's compensation for the restructuring, while very large in dollar terms, was tiny in relation to the total amount of shareholder wealth that was created. And the layoffs were carefully tailored to the needs of the business; they were not simply set arbitrarily high, to please Wall Street. In the case of United's restructuring, what impressed me was how complicated the whole thing was, how many different issues had to be addressed at the same time to keep the deal on track. In the end, management devised a whole new way of reporting the company's earnings, to address a deficiency in GAAP reporting rules as they pertain to employee buyouts. It took more than a year for analysts and investors to embrace the concept, but in the end I believe this accounting innovation played an important role in the ultimate financial success of the restructuring. Some critics have pointed to recent labor unrest at the airline as evidence that the restructuring failed, but this misses the point that for six years, the restructuring unambiguously reduced the firm's cash labor costs, by a significant amount—and at a time the other major airlines were laying off tens of thousands of employees.

Q: Who can benefit by reading this book?

A: I am trying to reach multiple audiences. Obviously one key target audience consists of educators and students, since the case studies in the book were developed for a course on corporate restructuring that I have taught here at Harvard Business School for the past eight years. (I have also taught these materials in a number of our executive education programs.) Currently there are very few courses offered on this topic at other business schools, I suspect in large part because, outside of the case study method, it is difficult for outsiders to know what transpires inside these companies, or understand management's perspective, given the sensitivity of the issues involved. I have been simply amazed at how frank and open the executives I worked with have been in discussing their experiences, and I do not know of another resource out there that can be used to teach students the actual practice of corporate restructuring. My goal was to show, through the lens of these managers and others involved, how a complicated and difficult restructuring actually gets done.

My book is also targeted at corporate executives, general managers and practitioners. Hopefully, investment bankers, strategy consultants, and attorneys will find it to be a useful guide or reference. In addition to the case studies, the book has chapters that describe the different techniques for restructuring companies, and summarize scholarly research on corporate restructuring. There is also a chapter that describes techniques for valuing companies in a restructuring situation. I think the case study method is ideally suited to teaching best restructuring practices, because it forces you to put yourself in management's shoes, and understand the issues and challenges that managers actually face in these situations. The case study method is all about getting you to ask the right questions.

Q: Did anything surprise you as you researched the book?

A: Two things stand out. First is the candor and ingenuity of the executives I interviewed. Some of the approaches that they came up with for dealing with incredibly complicated and difficult challenges are, I think, truly ingenious. But the executives were also very open about discussing what, in their view, they might have done differently if given a second chance. A second surprise was how permanent restructuring has become in the daily fabric of business and commerce. One can no longer think of restructuring as a rare event that happens to "someone else." All around the world, as trade barriers continue to fall, and capital markets become more integrated, restructuring is becoming a daily event, and every manager can benefit from having a basic understanding of effective restructuring strategies and practices. Every year I issue a guarantee to my MBA students: Within three years of graduating, every single one of them will encounter a restructuring on their jobs—whether it involves their own company, or the restructuring of a competitor, customer, or supplier. So far not a single student has come back and told me I was wrong.