Corporate restructuring has been a significant area of interest in helping to understand the limits of firm growth, the implications of changes in the firm's business portfolio, as well as the effectiveness of changes in organizational and capital structures (Bergh, 2001; Bowman & Singh, 1993; Filatotchev & Toms, 2006; Johnson, 1996). Portfolio restructuring involves the process of divesting and acquiring businesses that entails a refocusing on the organization's core business(es), resulting in a change of the diversity of a firm's portfolio of businesses (Bowman, & Singh, 1993; Bowman, Singh, Useem & Bhadury, 1999).
A multitude of empirical and theoretical investigations into the antecedents of restructuring revealed that the premier explanation of asset restructuring is the agency explanation, which suggests that firms engage in restructuring as a direct response to less-than-desirable performance (Hoskisson & Hitt, 1994; Hoskisson, Johnson & Moesel, 1994; Johnson, 1996; Johnson, Hoskisson & Hitt, 1993). Additionally, it is posited that the suboptimal performance is driven by managerial inefficiencies arising from weak governance mechanisms. Due to its overwhelming acceptance by researchers, the agency explanation has made portfolio restructuring synonymous with weak or poor governance (Bethel & Liebeskind, 1993; Chatterjee et al., 2003; Markides & Singh, 1997). Research has not proven that governance is weak in the pre-restructuring period, yet this school of thought has become ingrained in the literature.
One area that has received little attention is post-restructuring governance. In calls for future portfolio restructuring research, Johnson (1996) asked if governance is truly weak or a complete failure in the pre-restructuring period, then what changes does a firm make in the post-restructuring period? The basic implications of this question is that if firms do not correct such inefficiencies or shortcomings, then the process of portfolio restructuring may be followed by renewed expansion or continued inefficiencies in various governance mechanisms.
This paper argues that firms suffering from poor performance in the pre-restructuring period will initiate governance changes in the post-restructuring period. The belief is that it is common for these firms to have their governance structures labeled as weak or inadequate. As such, boards of directors and the CEO are pressured to not only address the performance issues but also address the governance issues that are frequently linked with poor performance.
To date, there has been no empirical examination that specifically addresses governance as an outcome of the restructuring process. Governance is the most discussed antecedent of portfolio restructuring, yet it is completely ignored in the post-restructuring period. Due to its overwhelming popularity, the agency explanation of restructuring suggests that firms suffering from poor performance in the pre-restructuring period will be saddled with the same weak governance structures they possessed in the pre-restructuring period if corrective actions are not taken. As such, the idea of governance reforms in the post-restructuring period has merit, but is yet to be addressed in the restructuring literature.
By drawing on the basic tenets of institutional theory (DiMaggio & Powell, 1983; Meyer & Rowan, 1977), this paper suggests that firms redesign their governance structures in post-restructuring periods to enhance, or even maintain, organizational legitimacy (Oliver, 1991). By changing governance structures that adhere to the prescriptions of rationalizing myths in the institutional environment, an organization may demonstrate that it is behaving on collectively valued purposes in a proper and adequate manner (Meyer & Rowan, 1977). Thus, by not making changes in post-restructuring governance structures, the firm becomes more vulnerable to claims that they are negligent or irrational. Additionally, conformity of organizations to normative pressures increases the flow of societal resources and enhances the chances of survival (Meyer & Rowan, 1977; Tolbert & Zucker, 1996).
The Institutionalization of the Agency Explanation of Restructuring
The premier explanation as to why organizations engage in portfolio restructuring is in response to substandard organizational performance, which is driven by managerial inefficiencies that, in turn, resulted from weak governance. An organization divests assets with the intent of improving performance, whether it is their performance in relation to competitors, the overall industry, or a predetermined aspiration level. In fact, research has demonstrated that firms engaged in restructuring often are performing poorly prior to the initiation of restructuring activities (Bergh, 2001; Bowman et al., 1999; Hoskisson & Hitt, 1994; Hoskisson et al., 1994; Johnson, 1996; Markides & Singh, 1997; Smart & Hitt, 1994). For example, Jain (1985) found that performance began to suffer approximately a year prior to divestiture and resulted in negative excess stock return of 10.8% within the one year prior to the restructuring event.
More commonly known as the agency explanation of portfolio restructuring (Filatotchev, Buck & Zhukov, 2000; Hoskisson & Hitt, 1994; Markides & Singh, 1997), poor performance as an antecedent of portfolio restructuring has become the leading explanation in the literature to account for restructurings since the 1980s. This explanation suggests that performance needs to be improved as a result of past managerial inefficiencies, which arise as a result of agency costs. Arguments are made that the board of directors, ownership concentration, and managerial incentives were ineffective and resulted in the failure of internal governance systems (Bethel & Liebeskind, 1993; Chatterjee & Harrison, 2001; Hoskisson et al., 1994; Jensen, 1993; Johnson, 1996).
Although never truly defined in the literature, weak governance is believed to be characterized by diffusion of shareholdings among outside owners, board passivity, and certain characteristics of managers and boards, such as minimal equity ownership by top managers and board members or an insufficient amount of outsiders sitting on the board (Bethel & Liebeskind, 1993; Dalton, Daily, Certo & Roengpitya, 2003; Johnson et al., 1993; Johnson, 1996; Westphal & Fredrickson, 2001).
Due to its overwhelming acceptance by restructuring researchers and its simplistic and intuitive appeal, the agency explanation has made portfolio restructuring synonymous with weak governance (Bethel & Liebeskind, 1993; Markides & Singh, 1997). Smart and Hitt echoed this sentiment by suggesting that "many of the arguments and concepts embedded in the agency literature seem so compelling that agency and governance related arguments have become a virtual de facto explanation for many types of corporate restructuring" (1996: 1). As a result, the academic and practitioner literatures on portfolio restructuring have devoted much effort to pointing out such alleged governance failures and highlighting ways of improving the corporate governance system of the modern corporation (Jensen, 1993).
Agency arguments have become ingrained in governance research that other paradigms are often ignored. Daily et al. referred to this barrier as empirical dogmatism, which they argued has negatively impacted researchers' willingness to "embrace research that contradicts dominant governance models and theories (e.g., a preference for independent governance structures) or research that is critical of past research methodologies or findings" (2003: 379). In essence, agency arguments have become the norm for viewing governance, and, as such, impact the organization of firms (e.g., the structure of the board). The agency arguments are embedded in how practitioners, institutional investors, and for the most part, academicians define what is good or sound corporate governance. In other words, there is remarkable consensus as to the best practices that need to reside in all firms if they are to maximize performance. Support for this idea was offered by Westphal and Zajac (1998) and Zajac and Westphal, who noted that "large investors appear to have co-opted normative agency theory to help legitimate their political agenda, thus contributing to and benefiting from the growth of agency theory as a dominant perspective on corporate control" (1995: 287-288).
Governance, Governance Reform, and Firm Performance
The literature suggests that large firms are under considerable pressure from concentrated ownership, such as institutional investors, to improve performance (Ryan & Schneider, 2002; Westphal & Zajac, 1997; Westphal & Fredrickson, 2001). These financial improvements include both corporate financial measures, such as operating and net income, and return on assets, as well as by stock valuation, which is a measure of the market's perception of firm value (Prevost & Rao, 2000; Ryan & Schneider, 2002). Additionally, these activist investors may extend their desired performance improvements to non-financial indicators of performance, such as enhancements in the composition of the board of directors and changes in the level and composition of executive pay (David, Kochhar & Levitas, 1998; Ryan & Schneider, 2002).
Institutional fund managers have been particularly effective in achieving governance changes in the firms they target (Dalton et al., 2003; Ryan & Schneider, 2002). In fact, there is evidence that pension funds have pressed organizations to initiate board changes in response to poor organizational performance (Daily & Dalton; 1995; Davis & Thompson, 1994). Among more commonly sought actions are increasing the proportion of outside directors and separating the positions of CEO and board chairperson. Thus, it is evident that ownership concentration can and does impact governance changes within firms suffering from sub-optimal...