R. Kumar, B.Com. MBA (Finance)
In earlier years, India was a highly regulated economy. To set-up an industry various licenses and registration under various enactments were required. The scope and mode of corporate restructuring was, therefore, very limited due to restrictive government policies and rigid regulatory framework.
Consequent upon the raid of DCM Limited and Escorts Limited launched by Swaraj Paul, the role of the financial institutions became quite important. In fact, Swaraj Paul’s bids were a forerunner and constituted a ‘watershed’ in the corporate history of India. The Swaraj Paul episode also gave rise to a whole new trend. Financially strong entrepreneurs made their presence felt as industrialists – Ram Prasad Goenka, M.R.Chabria, Sudarshan Birla, Srichand Hinduja, Vijay Mallya and Dhirubhai Ambani and were instrumental in corporate restructuring.
The real opening up of the economy started with the Industrial Policy, 1991 whereby ‘continuity with change’ was emphasized and main thrust was on relaxations in industrial licensing, foreign investments, and transfer of foreign technology etc. For instance, amendments were made in MRTP Act, within all restrictive sections discouraging growth of industrial sector. With the economic liberalization, globalization and opening up of economies, the Indian corporate sector started restructuring to meet the opportunities and challenged of competition.
Today, a restructuring wave is sweeping the corporate sector over the world, taking within its fold both big and small entities, comprising old economy businesses conglomerates and new economy companies and even the infrastructure and service sector. Mergers, amalgamations, acquisitions, consolidation and takeovers have become an integral part of new economic paradigm. Conglomerates are being formed to combine businesses and where synergies are not achieved, Demergers have become the order of the day. With the increasing competition and the economy, heading towards globalization, the corporate restructuring activities are expected to occur at a much larger scale than at any time in the past, and are stated to pay a major role in achieving the competitive edge for India in international market place.
The process of restructuring through mergers and amalgamations has been a regular feature in the developed and free economy nations like Japan, USA and European countries with special reference to UK where hundreds of mergers take place every year. The mergers and takeovers of multinational corporate houses across the borders has become a normal phenomenon.
The unleashing of Indian economy has opened up lucrative and dependable opportunities to business community as a whole. The absence of strict regulations about the size and volume of business encouraged the enterprises to opt for mergers and amalgamations so as to produce on a massive scale, reduce costs of production, make prices internationally competitive etc. Today Indian economy is passing through recession. In such a situation, corporates which are capable of restructuring can contribute towards economic revival and growth. Despite the sluggish economic scenario in India, merger and amalgamation deals have been on the increase. The obvious reason is – as the size of the market shrinks, it becomes extremely difficult for all the companies to survive, unless they cut costs and maintain prices. In such a situation, merger eliminates duplication of administrative and marketing expenses. The other important reason is that it prevents price war in a shrinking market. Companies, by merging, reduce the number of competitors and increase their market share.
In the words of Justice Dhananjaya Y.Chandrachud, Corporate restructuring is one of the means that can be employed to meet the challenges which confront business
The sweeping wave of economic reforms and liberalization, has transformed the business scenario all over the world. The most significant development has been the integration of national economies with ‘Market-oriented Globalized Economy’. The multilateral trade agenda and the World Trade Organization (WTO) have been facilitating easy and free flow of technology, capital and expertise across the globe.
Globalization gives the consumer many choices – technologies are changing, established brands are being challenged by value – for money products, the movement of goods across countries is on the rise and entry barriers are being reduced. As markets consolidate into fewer and larger entities, economies become more concentrated. In this international scenario, there is a heavy accent on the quality, range, cost and reliability of product and services. Companies all over the world have been reshaping and repositioning themselves to meet the challenges and seize the opportunities thrown open by globalization. The management strategy in turbulent times is to focus on core competencies – selling loss making companies and acquiring those, which can contribute to profit and growth of the group. The underlying objective is to achieve and sustain superior performance. In fact, most companies in the world are merging to achieve an economic size as a means of survival and growth in the competitive economy. There has been a substantial increase in quantum of funds flowing across nations in search of restructuring and takeover candidates.
Corporate restructuring involves restructuring the assets and liabilities of corporations, including their debt-to-equity structures, in line with their cash flow needs in order to,
• Promote efficiency,
• Restore growth,
• And minimize the cost to tax payers.
Corporate governance refers to the framework of rules and regulations that enable the stakeholders to exercise appropriate oversight of a company to maximize its value and to obtain a return on their holdings.
Fundamental cultural and institutional changes are required if a new corporate governance structure is to be established with arm’s-length, transparent relations between corporations, government, and banks. Changing corporate governance, however, is a long-term process Global enterprises may be motivated to reorganize their worldwide tax and legal structure for a variety of reasons. For example,
• To fully realize the value anticipated from a strategic merger or acquisition, a global enterprise must quickly reorganize and integrate its combined business operations from a tax and legal perspective.
• On the other hand, a fully integrated global enterprise may be forced to quickly realign its worldwide structure in order to effect a strategic spin-off or disposition of business operations that the management no longer deems desirable or essential.
• Finally, a global enterprise may wish to reorganize its worldwide structure to accommodate a down-sizing or transformation of its existing business operations or simply to generate tax and legal efficiencies that will contribute to its overall earnings per share.
Whatever the objective, to be truly successful, a global reorganization must be structured in a manner that not only,
• Optimizes the ultimate tax position of the enterprise,
• But also addresses a multitude of legal issues that arise as a result of the restructuring.
v Restructuring Techniques:-
Corporate restructuring can take several forms,
• Mergers and acquisitions
• Portfolio restructurings
• Financial restructurings.
Restructuring may also be classified into following forms,
• Financial restructuring
• Technological restructuring
• Organizational restructuring
The most commonly applied tools of corporate restructuring are
• Amalgamation • Joint venture
• Merger • Divestment
• Demerger • Strategic alliance
• Slump sale • Franchises
v Corporate failures:-
“God, but its hard making predictions!…….. Especially about the future” – Alphonse Allais.
The under mentioned causes result is increased number of corporate failures.
• Business failure and reorganization:-
Business failure occurs due to different reasons. While few firms fail within first year or two of life, few others grow, mature and fail much later. The failure can occur in a number of ways and also from different reasons. Business failure can be considered from,
• Economic and,
• Financial view point.
• Why business firms fail:-
Let’s see different reasons same makes failure to corporate:
• An imbalance of skills within the top echelon.
• A chief executive who dominates a firms operations without regard for the inputs of peers
• An inactive board of directors. The board of Directors lack of interest in the financial position of the company may lead to insolvency.
• A deficient finance function within the firm’s management.
• The absence of responsibility for the chief executive officer.
Apart from the above mistakes the firm usually is vulnerable to several mistakes,
• Management may be negligent in developing effective accounting system
• The company may be unresponsive to change
• Management may be inclined to undertake an investment project that is
disproportionately large relative to firm size. If the project fails the probability of insolvency is greatly increased.
• Finally the management may rely heavily on debt financing that even a minor problem can place the firm in a dangerous position.
v Symptoms of bankruptcy or failure:-
Having understood the causes for a firm’s sickness, the next important question is – is it possible to with reasonable accuracy predict a firm’s failure using some modeling technique.
Research shows that as a company enters the final stage prior to failure – a pattern may develop in terms of – changing financial ratios which prove to be useful indicators of an impending disaster.
Altman has developed a statistical model and found the statistical ratios best predicting bankruptcy. Based upon Altman’s sample of bankrupt firms the study yielded an equation that used five ratios to predict bankruptcy.
Bankruptcy score = 1.2X 1+ 1.4X2 + 3.3X3 + 0.6X4 + 0.999X5
X1 = Networking Capital / Total assets
X2 = Retained earnings / Total assets
X3 = Earnings before interest and taxes / total assets
X4 = Total market value of stock / book value of total debt
X5 = Sales / total assets
The Analysis:- The Z-score was developed from an analysis of 33 – Bankrupt manufacturing companies with average assets of $6.4 million, and, as controls, another 33 companies with assets between $1 million and $25 million.
Atman’s Z-score calculates 5 ratios,
1 return on total assets
2 sales to total assets
3 working capital to total assets
4 retained earnings to total assets
These ratios are then multiplied by a predetermined weight fact or and the results are added together. The final number–the Z-score–yields a number between -4 and +8.
The research showed that Financially-sound companies show Z-scores above 2.99, while those scoring below 1.81 are in fiscal danger, maybe even heading toward bankruptcy. Scores that fall between these ends indicate potential trouble.
In Altman’s initial study of 33 bankrupt companies, Z-scores for 95 % of these companies pointed to trouble or imminent bankruptcy.
Although the numbers that go into calculating the Z-score (and a company’s financial soundness) are sometimes influenced by external factors, it provides a good quick analysis of where the company under study stands compared to the competition, and provides a good tool for analyzing the ups and downs of the company’s financial stability over time.
The Altman Z-Score Analysis – 5 Ratios :-
|RATIO||FORMULA||WEIGHT FACTOR||WEIGHTED RATIO|
|Return on Total Assets|
|Earnings Before Interest and Taxes —————————————– Total Assets||x. 3.3||-4 to +8.0|
|Sales to Total Assets|
|Net Sales —————————————– Total Assets||x 0.999||-4 to +8.0|
|Equity to Debt|
|Market Value of Equity —————————————– Total Liabilities||x 0.6||-4 to +8.0|
|Working Capital to Total Assets|
|Working Capital —————————————– Total Assets||x 1.2||-4 to +8.0|
|Retained Earnings to Total Assets|
|Retained Earnings —————————————– Total Assets||x1.4||-4 to +8.0|
v The physiology of business failure:-
In an economic sense business failure is associated with success in business relates to firms that earn adequate return on their investment. Similarly business failure is associated with forms that cannot earn adequate returns on their investments.
What is important is whether a business failure is permanent or temporary. In fact the appropriate course of action depends on whether the business failure is permanent or temporary. Thus if the failure is temporary the firm may have to be liquidated and if the failure is permanent the firm may have to take steps to the speed the company’s return to business.
Types of business failure:-
A firm may fail if its returns are negative or even low. A firm that consistently reports losses at operational level would experience decline in market share and eventual closure.
• Technical insolvency:-
A firm is said to be facing technical insolvency when it is unable to pay its liabilities as they become due.
Thus when a firm faces technical insolvency its assets are still greater than the liabilities but the firm is confronted with liquidity crisis.
When a firm has technical insolvency some of its assets could be converted to cash to escape complete failure. If this is not done at right time, the firm may have to face a more serious type of failure – Bankruptcy. It occurs when firm’s assets are less than the liabilities. A bankrupt firm has a negative shareholder’s equity. Although bankruptcy is a more obvious form of business failure courts treat technical insolvency and bankruptcy in the same way.
v The challenge:-
When a firm faces severe problems, either the problems must be resolved or the firm must be liquidated. At such point an important question has to be answered – “is the firm worth more dead or alive”.
The decision to continue operating has to be based upon – The feasibility and fairness of reorganizing the firms as opposed to the benefits of liquidating the business.
When technical insolvency occurs management must either modify the operating financial conditions or terminate the firm’s life
If a decision is made to alter the company in the hopes of revitalizing its operations,
- Either voluntary agreements with the investors, or
- A formal court arranged reorganization must be used.
If on the other hand the difficulties are believed to be insurmountable, then liquidation will take place either by assignments of assets to an independent party for liquidation or by formal bankruptcy proceedings.
v Voluntary remedies to Insolvency:-
Once a firm begins to encounter these difficulties the firm’s owners and management have to consider the alternatives available to failing business. Such a firm has two remedies,
- Attempt to resolve its difficulties with its creditors on voluntary or informal process.
- Petition the courts for assistance and formally declare bankruptcy.
The company creditors also may petition to courts and get the company involuntarily declared bankrupt.
v To reorganize or liquidate:-
Regardless of whether a business chooses informal or formal methods to deal with its difficulties eventually the decision has to be made whether to reorganize or liquidate the business. Before this decision can be made both the business liquidation value and its going concern value has to determine.
Liquidation value: equals the proceeds that would be received from the sale of the business less its liabilities.
Going concern value: equals the capitalized value of the company’s operating earnings less its liabilities.
Normally, If the going-concern value exceeds the liquidation value the company needs to be reorganized otherwise it should be liquidated.
However in practice the determination of the going concern and liquidation values is not easy due to following reasons,
- Uncertainty as to estimating the price the company’s assts will bring at auction.
- The company’s future operating earnings
- Appropriate discount rate at which to capitalize the earning may be difficult to determine.
- Management understandably is not in a position to be completely –objective, about the above values.
v Informal alternatives for failing business:-
Regardless of exact reasons why a business begins to experience difficulties Regardless of the exact reasons why a business begins to experience difficulties the result is often same – Cash flow problems
- The first step taken by troubled company involves stretching its payable. In some occasions this can keep the company busy for several weeks of needed time before creditors take action. If the difficulties are more than just minor and temporary the company may turn to its bankers with request for additional working capital loans.
- Another possible action is the company bankers and creditors take up to restructure the company’s debt.
Restructuring of debt by bankers can be quite complex. However debt restructuring basically involves either
• Composition, or
• A combination of both above.
- In Extension:– The failing company tries to reach an agreement with its creditors that will permit it to lengthen the time for meeting its obligations.
- In composition:– The firm’s creditors accept some percentage amount lees than their original claim and the company is permitted to discharge its debt obligations by paying less than the full amounts and are protected from any further actions on part of creditors while it attempts to work out a plan of re-organization.
v What to do with the failing firm:-
Another important aspect of the bankruptcy procedures involves what to do with the failing firm. Just as in case of informal alternatives a decision has to be made about whether a firm’s value as a going concern is greater than its liquidation value. Generally if this is so a suitable plan of reorganization can be formulated and the firm is reorganized otherwise it is liquidated.
If a voluntary remedy such as an extension or composition is not workable a company can declare or be forced by its creditors into bankruptcy.
As a part of this process a firm is either reorganized or dissolved.
Reorganization is similar to an extension or composition, the objective being to revitalize the firm by changing its capital structure – like,
• Reduction of fixed charges by substituting equity and limited income securities in place of fixed income securities, etc.
Corporate restructuring can occur in myriad ways. Mergers, takeovers, divestitures, spin-offs, and so on referred to collectively as corporate restructuring have become a major force in the financial and economic environment all over the world.
v Dynamics of restructuring:-
In an incisive study on corporate restructuring covering a number of companies over an extended period of time Gordon Donalson examined the dynamics of corporate restructuring.
He tried to look at issues like why corporate restructuring occurs periodically, what conditions or circumstances induce corporate restructuring and how should corporate governance be reformed to make it more responsive to the needs of restructuring. The key insights of this study are as below,
- Even though the environmental change which warrants corporate restructuring is a gradual process, corporate restructuring is often an episodic and convulsive exercise. Why? Typically an organization can tolerate only one vision of future, articulated by its chief executive and it takes time to communicate that vision and mobilize collective commitment. Once the strategy and structure that reflect that vision are in place, they acquire a life of their own. A constituency develops with a vested interest in that strategy and structure which resists change unless it becomes inescapable.
- Hence Gordon Donalson says “hence resistance to change often preserves the status quo well beyond its period of relevance so that when change comes the pent up forces like an earthquake capture in one violent moment a decade of gradual change.
- The conditions or circumstances which seem to enhance the probability of voluntary corporate restructuring but not necessarily guarantee same are,
- persuasive evidence that the strategy and structure in place have substantially eroded the benefits accruing to one or more principal corporate constituencies
- a shift in the balance of power in favor of the disadvantaged constituency
- availability of options to improve performance
- Presence of leadership which is capable of and willing to act.
- Corporate restructuring occurs periodically due to an on going tension between the organizational need for stability and continuity on one hand and economic compulsion to adapt to changes on the other. As Gordon Donaldson says, “ the ‘wrongs’ that develop during one period of stable strategy and structure are never permanently rightened because each new restructuring becomes the platform on which the next era of stability and continuity is constructed.
v Organizational restructuring exercise:-
Many firms have begun organizational exercises for restructuring in recent years to cope with heightened competition. The common elements in most organizational restructuring and performance enhancement programmes are described below,
• Regrouping of business: firms are regrouping the existing businesses into a few compact strategic business units which are often referred to as profit centers. For example L&T ahs been advised by Mckinsey Consultants to regroup its twelve businesses into five compact divisions.
• Decentralization: to promote a quicker organizational response to dynamic environmental developments, companies are resorting to decentralization, de-layering, and delegation aimed at empowering people down the line. For example, Hindustan lever Ltd., has embarked on an initiative to reduce.
v Portfolio restructurings:-
Mergers, asset purchases, and takeovers lead to expansion in some way or the other. They are based on the principle of synergy which says 2 +2=5 !
Portfolio restructuring, on the other hand, involves some kind of contraction through a Divestiture or a De-merger is based on the principle of “synergy” which says 5 -3 = 3!
v Corporate strategy :-
Towards reorganizing themselves companies need to develop a strategy.
The conditions companies must satisfy if they are to conserve their essential characteristics over time may be summed up as –
• Consistency between their strategy, and
• The characteristics of the external environment in which they operate.
Owing to technological change and evolution as well as owing to heightened competitive pressures following,
• Market globalization and,
Companies increasingly have to cope with altered conditions of competition. In response they are forced to change their strategic framework.
Companies also need to change the way they compete and also the basic assumptions underlying the planning criteria that they adopt for their more general strategic design/architecture and those that govern the ways in which they interact with the external environment.
These changes have a bearing on,
• The companies ability to control environment variables
• The degree of company dependence on the external environment
• The very nature of the variability to be controlled.
Uncertainty has become the central element of competitiveness and business environment. In a world defined by turbulence surprise and a lack of continuity predictions are increasingly erroneous and therefore dangerous. This turbulence is being caused by,
• Acceleration of technological process
• The globalization of competition
• The restructuring of capitalism on a global scale.
• The slowing down of growth in some key sectors
• The political changes
• The high growth rates of Asian countries
• The large imbalance in global economy.
In a world, where prediction is becoming less reliable, decision-making and management models are perennially evolving, successful companies are organizing to become progressively “ready for anything”.
They are equipping themselves to be able to seize unexpected opportunities and retreat rapidly from bad risks. This evolution is centered on,
• Improvement of strategic analysis and thinking in terms of scenarios
• The anticipated development of additional capabilities in key resources
• Increased speed of action and reaction through efficient process of learning and change.
Organizations are restructuring themselves to meet changing environment. For three decades after world war two most economies around the world witnessed historically unparalleled progress. However after the early 1970s growth in most of industrialized economies began to slow down, affecting much of the developing world particularly adversely during the 1980’s and 1990’s. There were a variety of causes of this change in the trajectory of growth some of a macro economic nature and others rooted in the structure of corporate organization and in inter-firm linkages.
The response to these pressures has been a significant change in macroeconomic policies amongst countries. Throughout the world there has been a surge toward deregulation and a feeling of barriers to the global flow of many resources. For some countries this has resulted in significant enhancement to economic growth but for others globalization has done little to enhance living standards and security. Thus the gains from globalization is not automatic they depend on response of producers to the changing competitive environment.
One critical area of change is to be found in organization of production. To cope with new competitive pressures firms have to deliver not just low-priced goods and services but also products of greater quality and diversity. This requires in the first instance that they reorient their internal organization, changing production layout, introducing new methods of quality assurance and instituting processes to ensure continuous improvement.
But these changes in themselves are not sufficient. They need to be complemented by alterations in the relationship amongst firms particularly with firms.
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