The good corporate citizen

Diversification, Refocusing and Economic Performance - Corporate Governance
May 23, 1997

These two books are very different in many respects but are also highly complementary. Both address fundamental issues concerning the scope of an organisation's activities and the manner in which such decisions are made.

Constantinos C. Markides has produced a closely argued research monograph, largely based on his Harvard doctoral thesis, which reports the outcome of a substantial empirical study of the phenomenon of refocusing and its impact on performance in large United States corporations during the 1980s.

Robert A. G Marks and Nell Minow, by contrast, provide a wide-ranging discussion of the concept of corporate governance, which they define as "the relationship among various participants in determining the direction and performance of corporations". Their book is a reflection on many years of scholarship and shareholder activism in the cause of good and open governance.

Markides starts from the thesis that a corporation has some optimal level of diversification owing to the interaction of reducing marginal benefits and increasing marginal agency and information-processing costs as the level of diversification increases. Beyond this optimal level, the resulting decline in profitability will create pressures to refocus on the more profitable activities and thus restore overall profitability and market value.

By examining aggregate acquisitions and divestitures among Fortune 500 companies, Markides shows that the pattern of restructuring after 1980 is a reversal of the trend towards unrelated diversification that characterised the 1945-1980 period. The evidence shows that companies that adopted refocusing strategies were those that were highly diversified and underperforming relative to their industry counterparts, and had an attractive core business area to which they could retreat. This was typically achieved by the divestment of unrelated businesses and the acquisition of others related to their core.

Having identified the factors that predispose a company to reorganise, Markides then proceeds to examine the effects of refocusing on market-value, profitability, and the interactions between refocusing, organisational structure and profitability. He demonstrates that market value improvements around the time of announcements to restructure are concentrated on the most overdiversified and least profitable companies, while similar announcements by firms classified as underdiversified create no abnormal returns to shareholders. It is interesting that the biggest abnormal returns occur on the day of the announcement, which, as Markides notes, is consistent with an efficient capital market. But it is much more interesting that around a quarter of the total abnormal returns occur in the week or so preceding the day of the announcement, which appears to be consistent with an unhealthy level of "insider" dealing, upon which Markides fails to comment.

The work provides general support for the proposition that for overdiversified firms, refocusing will lead to profitability improvements. The effect is most evident in those companies that reorganised during the early 1980s, perhaps because the benefits take some time to materialise. Markides hypothesises that as firms refocus, then more centralised forms of the M-form structure will be required. This is because of the changing role of the corporate centre, from that of merely allocating resources on the basis of divisional profit performance, to that of greater involvement in operational decisions and the exploitation of "interrelationships and synergies among fewer and more related units". The results support the hypothesised structural changes and their positive impact on performance, but suggest that such adjustments take time to implement through the evolution of new information systems and control processes.

Markides's work is thoughtful and carefully explained and though it is based entirely on US data, it provides some insight into the refocusing trend now apparent among some large UK companies such as BAT, ICI and Hanson Trust. However, after reading the book, one's thoughts are inevitably drawn back to the question of why firms diversify beyond their optimal level in the first place. Though Markides devotes some six pages to this issue, Monks and Minow provide much more insight into this specific topic and more generally into the use and abuse of power by those who control and influence large corporations.

Corporate Governance contains several examples of companies which have found themselves in crisis as a result of overdiversification, including extensive case studies of Sears, Roebuck and Co and American Express. In their chapter on management performance, Monks and Minow opine that: "In general, the more diversified and conglomerated the company, the more likely it is to reflect the chief executive officer's empire building and the less likely that it demonstrates focus and commitment to shareholder value". Unfortunately the book went to press too early to allow Monks and Minow to reflect upon the irony of Hanson Trust's role in ICI's demerger of Zeneca and their own split into four separate companies.

This book is organised into five substantive chapters, four of which focus in turn on the role and responsibilities of the corporation, shareholders, directors and management, drawing mainly but by no means exclusively on US cases. Chapter five surveys governance practices and recent developments across 12 major industrialised nations including Japan, Hong Kong, Singapore and Switzerland. Chapter six consists of eight major case studies of significant governance issues in well-known US corporations. While Monks and Minow comment on the issues within each case, and refer to the cases from the more substantive chapters, it is perhaps unfortunate that there is no linking text to draw out the similarities and differences between them. Finally, there are ten appendices which reproduce key articles and other documents relating to general governance issues.

The book will provide a fascinating read for anyone with a keen interest in the subject. Coverage of all the major issues is extremely comprehensive. These include the purposes and role of the corporation in society, the balancing of stakeholder interests, the responsibilities of shareholders (both individual and institutional), shareholder activism, the combined role of CEO-chairman, independent (nonexecutive) outside directors, interlocking directorships, the composition of key board committees, executive compensation schemes, and many others too numerous to mention. The whole theme and ideological stance of the book is neatly summed up in the brief conclusion to chapter four, where the authors pose the question, "Who is in the best position to make a given decision about the direction of a corporation, and does that person or group have the necessary authority?" and answer that "Decisions should be made by those with the fewest conflicts (of interest) and the most information".

Corporate Governance is rich in examples of both good and questionable practice and it attempts to deliver a powerful message. However, some students of the subject may find the work off-putting, particularly those who are new to the area, who might prefer a book with shorter chapters and a more explicit conceptual scheme to guide the uninitiated through the wealth of detail.

Both books could usefully find a place on any MBA programme; Markides because his topic is emerging as a key theme in corporate strategy, and also as an example of a scholarly, systematic programme of empirical research which delivered useful if somewhat predictable results.

Monks and Minow may do students more good in opening their eyes to the issues of corporate accountability, good citizenship and the primacy of shareholder and broader societal interests over those of management and directors.

Charles Wilkinson is MBA programme director, Management School, University of Southampton.

Diversification, Refocusing and Economic Performance

Author - Constantinos C. Markides
ISBN - 0 262 13311 3
Publisher - MIT Press
Price - £26.50
Pages - 207

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