Mobile Edition
Print
Get the Mag
Weekly UpdatesABSTRACT
This study extends the transaction cost economics (TCE) rationale to a firm's choice of two restructuring alternatives--selling off assets and laying off employees. It hypothesizes that a firm's preference between sell-off and layoff depends on the underlying transaction costs, which in turn are contingent on the relative specificity of physical and human assets. The findings of this study empirically support the hypotheses, and emphasize the importance of relative asset specificity, unlike many TCE studies.
Keywords: Strategy, Restructuring, Transaction Cost Economics, Layoff, Sell-off
INTRODUCTION
Researchers and practitioners employ the term corporate restructuring to denote rapid changes in a firm's portfolio of assets, organizational structure or capital structure (Bowman and Singh, 1993). Asset divestitures and layoffs are two important restructuring alternatives that partially represent changes in a firm's portfolio of assets and organizational structure respectively.
This paper empirically investigates the question: when does a firm predominantly engage in asset divestiture, as opposed to layoff, and vice versa? According to the neoclassical economics literature, the decision to reduce physical or human assets (resources) simply involves a simultaneous comparison of the corresponding marginal rates of technical substitution, along with the consideration whether physical and human assets are substitutes (cf. Jorgenson, 1972) or complements (cf. Griliches, 1969) in a firm's production function. In any case, the choices in the reduction of physical and human assets are "syncretic or simultaneous." It is in this sense that we use the term (restructuring) "alternatives" in this paper.
The choice of a restructuring alternative is a key area in corporate decision-making (Reis and Brunet, 1990) because it has implications for firm efficiency and competitiveness (cf. Bowman, Singh, Useem and Bhadury, 1999). The neoclassical paradigm recognizes that in competitive markets, an efficiency-seeking firm may reduce assets based on asset prices and productivity (cf. Lichtenberg, 1992). However, several researchers have criticized the neoclassical "firm-as-aproduction-function" approach because it does not consider the behavioral costs and implications of human actors (cf. Teece and Winter, 1984).
In this paper, we highlight the transaction costs of restructuring--i.e., costs that are attributable to strategic human behavior (cf. Coase, 1937; Williamson, 1975, 1985). We argue that the choice of sell-off over layoff (or vice versa) involves a comparison of corresponding transaction costs. Because transaction costs are largely dependent on asset specificity, the choice between sell-off and layoff is impacted by the relative specificity of physical and human assets. A highly specific asset is one that has a much lower value in alternative uses or to other users. By choosing the appropriate restructuring alternative, a firm can economize on the attendant transaction costs, and stay competitive.
Sometimes restructuring may also involve downscoping (Hoskisson and Hitt, 1994), which is a reduction in a firm's output diversity (De Witt, 1998). A firm's decision to de-diversify its output is often driven by a desire to reduce relatively unproductive assets (Lichtenberg, 1992). Therefore, we primarily focus on input or asset reduction instead of output reduction (downscoping). We also assume that asset reduction is a given because our purpose is not to generally examine when restructuring occurs (e.g., in financial distress), but to specifically evaluate the criteria underlying the choice between sell-off and layoff, as soon as the asset reduction decision is imminent.
The existing literature on comparative approaches to restructuring alternatives is mostly exploratory and practitioner-oriented (e.g., see Reis and Brunet, 1990). Our framework should provide a more rigorous conceptual and empirical basis for the evaluation of sell-off and layoff decisions in a firm.
Williamson (1992, p. 350) has urged researchers to explore transaction costs economics (TCE) for new applications in organizational analysis. Our analysis extends the TCE rationale to the evaluation of restructuring alternatives, an important area in organizational decision-making. Williamson (1991a) has argued that competition often forces a firm to align the transaction mode with transaction parameters, such as asset specificity in order to be efficient. Unlike many TCE studies, however, we alert managers about the relative significance of different types of asset specificity for a firm's efficiency and competitiveness.
We organize the rest of the paper as follows. First, we examine the determinants of restructuring alternatives. Second, we lay out the rudiments of transaction cost economics. Third, we develop hypotheses regarding the impact of the types of asset specificity on restructuring transactions. Next, we test our hypotheses empirically. We conclude by discussing our findings, the potential limitations, implications for future research, as well as the contributions of our study.
DETERMINANTS OF RESTRUCTURING ALTERNATIVES
We investigate two possible restructuring alternatives: sell-offs and layoffs. The term sell-off is similar to the term partial sell-off, which was used by Ravenscraft and Scherer (1987). It includes the sale or partial divestiture of physical assets, such as land, machinery or equipment. We do not limit its usage to the divestiture of an entire plant. We use the term layoff to denote a permanent and involuntary reduction (on the part of workers) in the workforce (cf. Schervish, 1983, p. 61).
There is some anecdotal evidence that sell-offs and layoffs occur independently, as well as together (Bowman, et al, 1999). For example, Hoskisson and Hitt (1994, pp. 164-165) state that a number of companies, including General Motors, IBM, Xerox, and UNISYS, have used layoff extensively as a restructuring strategy. The authors advocate the divestiture of unrelated businesses when layoffs serve no other purpose than "bloodletting."
The early literature on restructuring does not distinguish clearly among different types of restructuring. As a result, we need to be cautious in making attributions about its possible determinants (Johnson, 1996). However, several studies cite declining firm profitability as an important determinant of restructuring activity. Factors, such as negative industry growth and increased competition may erode a company's profitability, which in turn, have a bearing on both sell-off (cf. Bergh 1995; Hamilton and Chow, 1993; Montgomery and Thomas, 1988; Ravenscraft and Scherer, 1987) and layoff (cf. Hitt and Keats, 1992; Kozlowski, Chao, Smith and Hedlund, 1993).
Very few studies have investigated why a firm would choose a particular restructuring alternative. De Witt (1998) suggests that a firm may sell off (downscale) its physical assets to boost profitability. However, recent investments in technology, capacity or new products may act as exit barriers. In such situations, it may be more attractive to retrench (realign and reengineer the organizational processes). In another study, Bowman, et al. (1999) state that layoffs have an inconsistent impact on firm performance. Perhaps restructuring (physical) assets may be a more attractive alternative when layoffs result in negative firm performance.
In general, (declining) firm profitability seems to be an important antecedent of the restructuring decision.
TRANSACTION COST ECONOMICS
A firm can substantially improve its profitability by way of restructuring by eliminating its slack, waste and bureaucracy. In fact, the gains in efficiency and competitiveness through the elimination of slack, waste and bureaucracy can be much greater than those achieved through "deadweight loss"--i.e., through the reduction of product price from monopoly levels to competitive levels (Williamson, 199 la).
A key source for reducing the organizational slack, waste and bureaucracy is to economize on the "transaction costs" by aligning the mode of transaction with its "parameters" (e.g., asset specificity, uncertainty and frequency--which will be explained later). Transaction costs include the costs of writing, negotiating, monitoring and enforcing a transaction, as well as the costs incurred if the transaction drifts out of alignment with its parameters (Williamson, 1985). Heterogeneity across firms in terms of pairing transaction parameters with the transaction mode can result in a competitive advantage (Nickerson, Hamilton and Wada, 2001).
Transaction cost economics (TCE) provides a theoretical and behavioral lens for comparing alternative transaction arrangements (Coase, 1937, 1960; Klein, Crawford and Alchian, 1978; Williamson, 1975, 1985; see David and Han, 2004 for a more recent review of the TCE literature). Traditionally, TCE has dealt with markets and hierarchies as alternative transactions. We use the insights gained from the traditional TCE literature to evaluate the sell-off and layoff decisions
We characterize sell-offs and layoffs as contracts or transactions. The former may be considered a transaction between a seller of physical assets (a firm) and a buyer, usually another firm. Layoff may be regarded as a transaction between an employer and employees (Shleifer and Summers, 1988).
The behavioral assumptions underlying TCE are bounded rationality and opportunism. Bounded rationality assumes that "human beings are intendedly rational but only limitedly so" (Simon 1961, p. xxiv). Opportunism implies "self-interest seeking with guile" (Williamson 1985, p. 47).
The transaction costs underlying sell-offs and layoffs arise out of the interplay between the behavioral assumptions and key transactional dimensions or "parameters," which are asset specificity, uncertainty and frequency (Williamson, 1985, p. 52). In this study, we primarily focus on the relationship between asset specificity and the (restructuring) transaction modes because asset specificity is believed to be the most important transactional dimension (David and Han, 2004). The empirical evidence regarding the impact of uncertainty on transactions has been generally inconsistent and inconclusive. Transaction frequency may not be a critical variable of interest in our study, given the occasional nature of sell-off and layoff transactions.
FEED