Measuring the Effect of Restructuring on Corporate Performance: The Case of Management

Buyouts
Author(s): Scott B. Smart and Joel Waldfogel
Source: The Review of Economics and Statistics, Vol. 76, No. 3 (Aug., 1994), pp. 503-511
Published by: The MIT Press
Stable URL: http://www.jstor.org/stable/2109975
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 MEASURING THE EFFECT OF RESTRUCTURING
ON CORPORATE PERFORMANCE: THE CASE
OF MANAGEMENT BUYOUTS
ScottB. SmartandJoelWaldfogel*
Abstract-Recent researchhas attemptedto documentthat
the financialgains associatedwith takeovers,LBOs and other
types of restructuringare attributableto subsequentimprove-
ments in operatingperformance.In this paperwe develop a
moregeneralframeworkfor measuringthe effectof corporate
restructuringon performanceand applythe frameworkto a
sample of firms taken private by their management.We
demonstratethat the estimationapproachesemployedin the
literatureembodyrestrictionson the generalframeworkwhich
the data can reject. However, our best estimates provide
evidencethat MBOsimprovecorporateperformance,and the
magnitudesof these improvementsare similar to existing
estimates.
I. Introduction
A GGROWING body of researchindicatesthat
corporaterestructuringgenerates value for
stockholders, and recent empirical evidence
points to improvementsin operatingperformance
as a primarysource of these gains. Kaplan(1989)
and Lichtenberg and Siegel (1989) study firms
taken private in management buyouts (MBOs)
and find that both financial(sales, income, etc.)
and real (factor productivity)performancemea-
sures improve after the buyout. Healy, Palepu
and Ruback (1990) also discover signs of asset
productivityimprovementsin a sampleof merged
firms.The authorsof these studies conclude that
MBOs, mergers and other types of corporate
restructuringgenerate operating efficiencies by
altering managerial incentives, reducing agency
costs and improvingfactor productivitythrough
other means. In contrast, a number of other
studies report results at odds with the view that
corporate restructuringgenerates long-run im-
provements in value. For example, Ravenscraft
and Scherer (1987a and 1987b) detect no evi-
dence of improvementsin post-takeoveroperat-
ing performancein a sample of merged firms.
Received for publicationSeptember19, 1992. Revision ac-
cepted for publicationOctober18, 1993.
* IndianaUniversity;and Yale Universityand NationalBu-
1
reau of EconomicResearch,respectively.
We would like to thank Steve Kaplan for providingpost- studies have attempted to match firms according to size,
buyout data on MBO firms. We are grateful to Michael leverage and other financial characteristics.In contrast,
Jensen, John Shoven,ChrisJones and two anonymousrefer- Jarrell (1991) employs an expectations-basedmethodology
ees for helpfulcomments.Any errorsare our responsibility. similarto the approachwe propose.
Copyright ? 1994
Mueller (1985) reaches similarconclusionsin his
studyof marketshare data.
Thoughtheir conclusionsdiverge,these studies
share the commongoal of measuringthe effect of
corporate restructuringon the performance of
firms.Answeringthis question is complicatedbe-
cause the relevant benchmark against which
post-reorganizationperformanceshould be mea-
sured is not preorganizationperformance.The
preferredbenchmarkincorporateschangesin ex-
pected performance for the restructuringfirms
prior to their decision to reorganize as well as
unanticipatedshocksto performanceunrelatedto
the restructuringdecision. It is difficultto find a
control measure that convincinglyanswers the
question, "what would have happenedto perfor-
mance at the restructuringfirmsin the absenceof
restructuring?"
In most cases, researchersattempting to ad-
dress this issue have measuredthe expost perfor-
mance of restructuringfirms relative to the re-
sults achievedby companiesoperatingin the same
industry.1The effect of restructuringis thus mea-
sured as a "differencein differences,"or as the
change in performanceat the restructuringfirm,
minusthe simultaneouschangein performanceat
the control firm(s).The chief shortcomingof this
approachlies in its assumptionthat, if not for the
restructuring,the reorganizingfirm would have
experiencedthe same change in performanceas
its competitors.If individualfirmshave their own
dynamicperformancepatterns,it may be unrea-
sonable to assume that except when organiza-
tional structurechanges, the performancemea-
sures of firmsin the same industrymove together.
An importantreason to doubt that the change
in performance at non-restructuringfirms pro-
vides an appropriatecontrol measure is that re-
In additionto matchingfirmsaccordingto industry,some
[ 503 ]
504 THE REVIEW OF ECONOMICS AND STATISTICS
structuringfirms are a non-random sample of
firms.The reasonsfor restructuringmay depend,
at least in part, on past and (expected) future
performance.For example, suppose that firms'
performancepatterns are positively autocorre-
lated and that restructuringsoccur when perfor-
mance is low. Suppose,further,that at any point
in time, the performancelevels of differentfirms
in an industryare at different levels relative to
their own historicalaverages.Then, independent
of the restructuring,we expect performanceim-
provementat the restructuringfirm. Equallyim-
portant,we do not necessarilyexpect the same
improvement at the "control" firms. Conse-
quently,the differencein differencesmay provide
a misleadingmeasure of the effect of restructur-
ing on performance.
An accuratemeasure of the effect of restruc-
turingon firm performanceis importantbecause
it sheds light on organizationalefficiency.In addi-
tion, the influenceof corporatecontrol events on
privatesector productivityis directlylinked with
a numberof publicpolicyconcerns.For example,
corporate restructuringaffects the tax revenue
collected from corporations. When companies
privatize,they typicallyreplace equity with debt.
While the cash flow previously paid to equity
holders faced corporateincome taxation,the in-
terest paymentspaid to post-buyoutdebtholders
escape corporate-leveltaxation. Jensen, Kaplan,
and Stiglin(1989)estimatethat the U.S. Treasury
has actually gained from management buyouts
(MBOs)because the tax revenuesgeneratedfrom
improvedcorporate cash flows have been large
enough to offset corporate tax losses associa-
ted with the increased usage of debt.2 Bulow,
Summers,and Summers(1990) show that these
gains to the Treasurydisappearwithout the im-
provementsin operatingperformance.Thus, it is
necessaryto determinewhether increasedcorpo-
rate cash flows are attributableto restructuringor
to other factors.
This paperpresentsa frameworkfor estimating
the effect of restructuringon performance.This
frameworkembraces as special cases the differ-
2
There are other tax effects of these transactionsincluding
extra capital gains taxes paid by selling shareholders,in-
creasedrevenuesfrom more efficientuse of capital,taxes on
debtor'sincomesand asset sales and so on. Some of these tax
effects(e.g., the added capitalgains taxes) are not contingent
upon future operatingperformance.However,the net effect
on the Treasury'srevenuesis negativewithoutthe operating
performanceimprovements.
ence in differences measure, as well as others.
Each special case entails a set of testable restric-
tions on the general framework.Using data on
performance at firms undertakingmanagement
buyouts(MBOs),we presenttests that distinguish
betweenvariousestimatorsfor the effect of MBOs
on performance,as well as our best estimates of
the MBO effect.
The paper is organized as follows. Section II
describeshow the circumstancessurroundingcor-
porate restructuringaffectthe measurementof its
effect on firm performance.Section III develops
a general empirical framework for measuring
the effect of reorganizationon firm performance
and discusses,thespecial cases of this framework
that have been employedin existingstudies. Sec-
tion IV describes data and empiricalestimation
of the componentsof the framework.Section V
presentsresults.A conclusionfollows.
II. The ReorganizationDecision
The numberand size of corporationsundertak-
ing significantrestructuringactivitiesin the form
of mergers, share repurchases, and leveraged
buyouts grew during the last decade, motivating
economiststo studythe effects of corporatereor-
ganization on various aspects of firm perfor-
mance. Jensen (1986) and others advance the
theory that some types of restructuringcreate
value by alteringthe incentivesof managersand
owners in a way that enhances efficiencyand by
reducing agency costs. Shleifer and Summers
(1988) suggest that corporate takeovers merely
transfervalue from employees and other stake-
holders of firms to shareholdersby breakingim-
plicit contracts.Similarly,Lowenstein(1985) dis-
cusses the possibility that managers who take
their companiesprivatein leveragedbuyoutshave
private information about their firm's future
prospects. This informationallows managers to
buy the companyfrom public shareholdersat a
pricebelow thatwhichan informedinvestorwould
pay. Thoughthis hypothesisimplies that financial
performance improves after the buyout, the
source of the value increase is not related to the
buyoutitself.
Whateverthe motivationfor corporatereorga-
nization, theory providesreasons to suspect that
these firmsare systematicallydifferentfromother
companies, and empiricalevidence supportsthe
theory. Neither the types of firmsthat choose to
 RESTRUCTURING AND CORPORATE PERFORMANCE
go private,nor the timing of the decision is ran-
dom. Palepu(1986),Smart(1992),and othersfind
that firms involved in corporatecontrol transac-
tions have characteristicsthat distinguishthem
from other firms.3 If these characteristicsare
correlated with future returns, then one must
account for these factors in order to obtain an
unconditional estimate of the effect of the re-
structuringdecision on returns.
Firms that are experiencingunusuallylow cur-
rent performancemay be more likely than other
firms to restructure. If this is the case, then
simply calculatingpre- and post-buyoutperfor-
mance changes may overstate the effect of the
reorganization.In addition,part of the change in
performance at the restructuringfirms is also
experiencedat other firms.For example,part of
the improvementat a firm that restructuresdur-
ing an industryslump is experiencedby all firms
in the industry and is not attributableto the
reorganization.4
Thus, there are two adjustmentsthat must be
made to raw changes in performanceto isolate
the effect of restructuring.Both the firm's ex-
pected change in performanceand contempora-
neous shocks felt at the firm and elsewheremust
be removed. Adjusting the change in perfor-
mance at a restructuringfirmwith the change in
performance at non-restructuringfirm will not
yield a correct estimate unless both the control
and restructuringfirm have the same expected
performanceimprovement.The followingsection
lays out a frameworkfor measuringthe effect of
restructuringon performancethat is valid even if
control and restructuringfirms have divergent
performanceexpectations.
III. An Empirical Framework
This section introducesa series of approaches
to estimatingthe effect of restructuringon per-
formance, including measures which have been
advancedin the literature.Each of the estimation
3 See also Shivdasani(1993)and Morck,Shleiferand Vishny
(1989).
4Consider the analogyof an auto workerwho decides to
return to school to get an M.B.A. If the worker chooses
graduateschool in part because of temporarilylow earnings,
then measuringthe effect of a graduatedegree on incomeby
takingthe differencebetween pre- and post-M.B.A.earnings
will yield an upwardbiased estimate.Besides this individual-
specific"low earningsshock,"wages of all auto workersmay
have experiencedeither a positive or negative shock during
the trainingperiod.
505
approaches examined is a special case of our
theoretically preferable general approach, and
each embodies testable restrictionson the gen-
eral framework.
The simplest possible measure of the effect of
restructuringon firm performanceis simply the
raw change in performanceafter the buyout oc-
curs:
(1)
XtRk -XtR'
where X is some measureof firmperformance,R
denotes a restructuringfirm,and subscriptst and
t + k refer to pre- and post-restructuringtime
periods. We will refer to the raw changes as
estimator(1). The problemwith this estimatoris
that it attributes the entire change in perfor-
mance to the reorganizationeven though some
portion of the change at the firm would have
occurred in the absence of any reorganization.
For example,observablemeasuresof firmperfor-
mance may be autocorrelated.If a firm'sperfor-
mance patternis cyclicaland restructuringoccurs
when the performancemeasure is below its his-
toricalmean, then some improvementis expected
and is not properlyattributableto the reorganiza-
tion.5 We can test whether performancechanges
are expected at restructuringfirms.
HYPOTHESIS A: E(XtR kIt) = XtR
Prior to the restructuring, performance is ex-
pected to remain at current levels.
Rejectionof the hypothesisthat no changesare
expectedindicatesthat the rawchangesestimator
is an inadequatemeasureof the effect of restruc-
turing because significantperformancechanges
are expected absent restructuring.
A natural way to deal with the problem of
anticipatedperformancechanges is to adjustthe
actual change in performancethat occurred for
(an estimate of) the expected change that would
have occurred without the buyout. Suppose we
have a measure of expected performanceat the
restructuringfirm in period t + k, E(Xt/kIt).
(Note that this expectation is taken at time t,
5Survivorship bias can generate the same type of effect.
Considerthe populationof firmsexperiencingbelow average
performanceat time t. Some of these firmswill survivein one
form or another,but others will cease to exist. Because any
sample of firms with continuouslyobservableperformance
data over some time interval will exclude those that go
bankrupt,we would expect to observeperformanceimprove-
ments amongthose firmsin the sampleinitiallydoing poorly.
506 THE REVIEW OF ECONOMICS AND STATISTICS

priorto the restructuringdecision, and it presup- The difference in surprises measure has the
poses that no organizationalchange will take following intuitive interpretation.Suppose that
place). Then the effect of reorganizationis only we have accountedfor every statisticallycontrol-
the part of the change in performancethat was lable aspect of the change in performance at
not expected prior to the buyout, or the restruc- restructuringand non-restructuringfirms pre-
turing surprise: dictable prior to the reorganization,except the
- E(XtR+klt). restructuringitself. What we have left is a set
Xtk (2)
of change-in-performancesurprises for the re-
Interpretingthis as a measure of the effect of structuring and non-restructuringfirms. The
restructuringrelaxes the assumptionof the first difference in surprises estimator is the average
approach that the expected change in perfor- difference in performancesurprisesbetween re-
mance in the absence of restructuringis zero. structuringand nonrestructuringfirms and may
While the restructuringsurpriseoffers an im- properly be interpreted as an estimate of the
provement over the raw change (1), it suffers effect of restructuringon firmperformance.
from the potential shortcomingthat it attributes
Separate from the progression of estimators
to the buyout any unforecastable change ex- above is a measureof the restructuringeffect that
perienced at the restructuringfirm even though has been used in the literature (Kaplan, 1989;
nonrestructuringfirms may experience the same Lichtenbergand Siegel, 1989, and others), the
performanceshock. That is, the surprise in ex- change in performanceat restructuringfirmsmi-
pression(2) will typicallyincludeboth firm-specific nus the change in performance for a control
'and more general shocks.6 If the restructuring sample of firms,
firm's industry does surprisinglywell following
the firm'sreorganization,then it would be incor- (Xt+k - XtR) - (Xt+k - Xt), (4)
rect to attributeall of expression(2) to restructur-
ing. We can test whether industryshocks under- or the difference in differences. A shortcoming of
mine the interpretationof estimator(2). this estimation approach is that it neglects the
possibility, discussed above, that some parts of
HYPOTHESISB: E(Xt+ k| t) = Xt+k (for controls) the changes in performanceat the restructuring
Thereare no performance shocks at controlfirms. and non-restructuring firms may be forecastable.
Rejection of hypothesis B indicates that esti- Our general estimator(3) reduces to expression
mator (2), while better than (1), still gives a (4) when the expected changes in performance
misleadingestimateof the effect of restructuring. are equal at restructuringand controlfirms.8We
Only the componentof the restructuringsurprise can test whetherthis conditionobtains,and hence
not experiencedby similarnonrestructuringfirms whether the differencein differencesmeasure is
is properlyattributedto the reorganization. appropriate,by examiningthe followinghypothe-
The possibilityof a performanceshock experi- sis:
enced by both restructuringand control firms
suggeststhat the effect of restructuringshouldbe HYPOTHESIS C: [E(Xt+ kIt) -X/R] =
measured as the performance surprise experi- [E(Xt+klt) - Xt]
at
enced restructuringfirms,less the performance Expected improvements at restructuringand con-
at
surprise comparablenon-restructuringfirms.7 trol firms are identical.
Our most general measure of the effect of a An example will help illustrate the difference
restructuringis then the restructuringsurprise among the estimators.Suppose that performance
minus the "controlsurprise,"or the differencein at XYZ Corp. is expected (in the absence of a
surprises: restructuring)to improveby 10% over the next
- - [Xt+k - E(Xt+klt)].
two years.9Suppose a buyout occurs and perfor-
[Xt+k E(Xt+klt)] mance improves15%. The restructuringsurprise
(3)
8An intuitivespecial case of this arises if no performance
6
For example,a petroleumfirm that went privatein 1990 improvementsare expectedat either type of firm.
would have experienceda performanceimprovementin 1991 9 In the empiricalsectionwe use the changein the ratio of
due to the Gulf Crisis,as did firmsremainingpublic. operatingincometo sales as our performancemeasure.Thus,
7Of course,findinga non-MBOcontrolfirmis not a trivial if the current income to sales ratio for XYZ is 0.10, an
matter,but we leave that concernfor the empiricalsectionof expectedimprovementof 10%impliesan expectedincometo
the paper. sales ratioof 0.11 in two years.
 RESTRUCTURING AND CORPORATE PERFORMANCE 507
TABLE l.-FOUR ESTIMATES OF THE RESTRUCTURING EFFEcr comparisonsbetween our results and the results
Raw Change = 15 of previousstudies.
Restructuring Surprise = 15 - 10 = 5 The data on actual performanceof MBO firms
Difference in Differences = 15 - (1) = 14
Difference in Surprises = (15 - 10) - (1 - 5) = 9 (X/?) come from two sources. Pre-buyoutdata
are primarily from COMPUSTAT's Research File,
althoughdata unavailableon COMPUSTATwere
obtained from 10-k's directly. Post-buyoutdata
is 5%. Suppose that the performanceat Refer- for 48 MBOs are obtained from the data set
ence Corp. is a relevantcontrol. Performanceat developed by Kaplan (1989).11 These firms were
Reference Corp.was expected to improveby 5% subject to public disclosure requirementsafter
but actually increased by 1%. The control sur- their buyouts either because they continued to
prise is thus - 4%. What is the restructuring have public securities (debt or preferred stock),
effect? Table 1 shows restructuringeffect esti- or because they sought additional public fund-
mates arising from each of the four estimators. ing.12Up to three years of post-buyoutdata, not
The raw change is 15%, but the difference in includingthe fiscalyear of the reorganization,are
surprisesis 9%. In principle,all estimatorsexcept availablefor each firm. In what follows, the first,
the difference in surprisesgive misleading esti- second, and third years after the buyout are re-
mates of the true effect of restructuring.The ferred to as t + 1, t + 2, and t + 3.
appropriatenessof each estimator in practice is The data on actual performance at control
an empiricalissue whichwe examinebelow. firms(Xe) come from two basic sources,COMPU-
STAT and Value Line. We use three different
control samples. From COMPUSTAT,we con-
IV. Data structan annualtime series of the aggregateratio
Estimation of the effect of restructuringon of operating income to sales at the 3-digit SIC
performanceusing the frameworkabove requires level. These 3-digitindustriesare chosen to match
us to create empirical analogues to each of the the 3-digit industriesof the MBO firms. In any
components of expression (3). These are com- year, we include all firmsthat have data for both
prised of two types of information,performance variables(COMPUSTATdata items 12 and 13).
and expectedperformance,for two differenttypes From ValueLine, we obtain two differentcontrol
of firms, restructuringfirms and control firms. measures of performance.First, for each MBO
Expected performance measures are obtained firm, we choose up to five individualValueLine
from both time series methods and analysts'fore- firmsof similarsize in the same SIC industry.We
casts.10 aggregatethese firms'operatingincome and sales
The performance measure (X) used in this figuresand use the aggregateratio as our second
study is the ratio of operating income to sales. control measure of performance.Alternatively,
Performancechanges are reportedin percentage we associate each MBO firm with a ValueLine
terms. We use a scaled measureto allow compa- industrygrouping,and we use ValueLine's aggre-
rabilityacross firms and to control (at least par- gate industry-grouping data as a control measure
tially) for post-buyout divestitures.In addition, of performancefor that firm.13
the income to sales ratio may be loosely inter- For both control and restructuringfirms, we
preted as a measure of the efficiencywith which must also derivemeasuresof the expectedchange
firmsutilize a given amountof sales. We scale by in performanceat the time of the restructuring
sales rather than assets because the accounting
value of assets typicallychanges at the time of a See Kaplan(1989) for a detailed descriptionof his data.
12A few firmsdisclosedtheir financialdata when they were
buyout,makingpre- vs. post-buyoutcomparisons sold to existingpubliccompanies.
13
difficult.Finally,our measureof performancehas ValueLine industrycategoriescorrespondonly loosely to
SIC
been used elsewhere in the literature (Kaplan, different codes and group together firms that operate in vastly
marketson dramaticallydifferentscales. It is not
1989;Jarrell,1991),so we are able to make rough uncommonfor ValueLine to group two firms whose SIC
codes are dissimilareven at the two-digitlevel. We preferon
10
a priori grounds using firm-specificdata to construct our
We employboth types of forecastsbecause of conflicting control measuresbecausewe can matchcontrol and restruc-
evidenceon the qualityof time series and analysts'forecasts. turingfirmsmore closely on the basis of firmsize and indus-
See, for example,Brownet al. (1987) and O'Brien(1986). try.
508 THE REVIEW OF ECONOMICS AND STATISTICS
firm's buyout. We derive expected changes in
performancefor the MBO firms (E(XtRklt) -
X/R) in two ways. First, we estimate a dynamic
performanceregressionon the MBO firms' an-
nualperformancehistoryup to the last pre-buyout
year using the ratio of operatingincome to sales
as the dependentvariable,and we use this regres-
sion to generateforecastsfor post-buyoutperfor-
mance. This regression includes one lagged de-
pendentvariableand allowseach firm a different
intercept. Our second measure of expected
change in performanceat the restructuringfirms
is the ratio of operatingincome to sales predicted
by Value Line. Value Line publishes a multi-year
forecastcoveringthe second throughfourthyears
following the buyout (years t + 2 to t + 4). We
obtainthe expectedchangein performanceas the
last forecast of performance before the an-
nouncementof the buyout.Thus, these expected
changes are the expectations of performance
changes in the absence of a buyout.
We derive expected changes in performance
for control measures (E(Xf+klt) - XI) in three
ways: (1) using autoregressionson SIC 3-digit
aggregate COMPUSTAThistory (in a fashion
analogousto the regressionson MBO history),(2)
by aggregating Value Line's performance fore-
casts for the 5 individualfirmsthat we matchwith
each MBO firm, and (3) using ValueLine's fore-
casts of industry aggregate performance.In all
three cases, the control forecastsare made given
informationavailableprior to the buyout at their
matchedMBO firms.
V. EmpiricalResults
In this sectionwe estimatethe effect of restruc-
turing on performance using data on MBOs.
We test between the measures discussed in sec-
tion III, and we present our best estimatesof the
MBO effect.
A. Choosing an Estimator
In principle,the most general measure of the
effect of restructuringis the best measure,since it
relaxes as many assumptionsas possible. Yet, in
choosing empirically among estimators for the
effect of restructuring,what matters is whether
the restrictionsembodiedby a particularestima- 14 These changesare measuredrelativeto the year immedi-
tor indeed hold. In what follows, we test the ately
15
restrictionsimplied by choices of various estima- this hypothesiswe need to measure expected performance
tors over others. In particular,we test hypotheses improvementsonly at restructuringfirms,not controlfirms.
that allow the data to distinguishbetween raw
changes and restructuringsurprises(1 vs. 2), be-
tween restructuringsurprisesand differences in
surprises (2 vs. 3), and between differences in
differencesand differencesin surprises(4 vs. 3).
Table 2 presents Wilcoxonstatistics(in paren-
theses) for these three hypotheses,estimatedover
the three different control groups' data. Figures
in columnA representthe median expected per-
formance improvements at restructuringfirms
measured as a percentagechange in the operat-
ing income to sales ratio.14For example, using
COMPUSTATdata we estimate that the median
expected change in the ratio of operatingincome
to sales is 4.0%by the firstyear after the buyout,
5.3% by the second year, and 7.0% in the third.
ValueLine forecasts show even larger expected
performanceimprovementsfor these firms,7.5%
by year two and 17.0% by year three, and they
are significantlydifferentfromzero.15Becausewe
consistentlyreject hypothesisA, it is inappropri-
ate to use raw changes to measure the MBO
effect as they will give an upwardlybiased esti-
mate of the true effect.
ColumnB containsmedianestimatesof control
firm surpriseswhich should theoreticallybe sub-
tracted from restructuringsurprisesto yield the
true MBO effect. Note that accordingto all of
our firm-specificdata,controlfirmsperformworse
than expected, and significantlyso by year three.
In other words, both COMPUSTATand Value
Line forecasts of the performanceof individual
control firms prove to be overly optimistic, al-
thoughthe ValueLine data on aggregateindustry
performance fail to reject the hypothesis that
control surprises are zero. To the extent that
control surprisesare significantlybelow zero, the
restructuringsurpriseestimatesunderestimatethe
MBO effect because they neglect simultaneous
negativeperformancesurprisesat controlfirms.
Column C presents median estimates of the
difference between restructuringfirms' expected
performanceimprovementsand that of control
firms.A positive estimate indicatesthat expected
improvementsat restructuringfirmsexceed those
at control firms, and therefore that the differ-
ences in differencesestimateswill exceed the true
priorto the buyout.
The bottom panel of columnA is blank because to test
 RESTRUCTURING AND CORPORATE PERFORMANCE 509

TABLE 2.-MEASURES OF THE DIFFERENCES BETWEEN ESTIMATORS

AND HYPOTHESIS TESTSa

Control N Ab Bc Cd

1. COMPUSTAT data used to forecast expected performance

t+ 1 35 4.0 -1.5 6.1
(2.19)' (-1.03) (1.92)9
t+ 2 31 5.3 -4.7 6.0
(2.19)' (-1.29) (1.96)'
t+ 3 14 7.0 - 28.7 -6.7
5.8 - 27.8 -11.7
(1.6) (-2.54)' ( -0.41)
2. Value Line data used to forecast expected performance
1. Individual firms
t+ 2 25 7.5 -7.9 1.0
(3.43)f ( - 2.52)' (0.96)
t+ 3 11 17.0 -18.3 4.6
(2.22)f ( 1.96)' (1.69)9
b. Industry aggregate datae
t+ 2 24 2.3 1.6
1.9 1.5
(0.77) (0.44)
t+ 3 10 2.3 4.0
1.9 1.6
(0.87) (0.76)
a
Wilcoxon statistics are in parentheses. Critical values for two-tailed tests are 1.96 and 1.65 for 95% and 90%
significance levels, respectively.
Ho: E(XR+klt) - = 0, or that the expected performance improvement at restructuring firms is zero.
Rejection indicates that estimator 2 provides an improvement over estimator 1.
Ho: XI+k - E(XI+klt) = 0, or that control surprises are zero. Rejection indicates that estimator 3 is more
appropriate than estimator 2.
d
Ho: [E(X/R+klt) - XR- [E(X,+klt) - XI] = 0, or that the control and restructuring performance measures
have the same expected improvements prior to the restructuring. Rejection indicates that estimator 3 provides an
improvement over estimator 4.
e Note that since there are an even number of firms in this panel and in year t + 3 of panel 1, there is no unique
median, so we report both medians. Since hypothesis B does not require industry adjustment, we do not repeat the
results from panel 2.
f Significant at 95%.
g Significant at 90%.

MBO effect. Our evidence on this hypothesisis
mixed. COMPUSTATdata suggestthat there are
significantdifferences between expected perfor-
mance at restructuringand control firms in the
shortrun (the firstand second post-buyoutyears),
but that these differencesdisappearby year three.
The Value Line firm-specificdata indicate that
MBO firms have greater expected performance
improvements,but they are significantat conven-
tional levels only in the third year. The industry
aggregatedata also indicate higherexpected per-
formancefor MBO firms,but the differencesare
not significant.The erraticestimatesfor the latter
years probablyreflect our small samples (fewer
than 15 firms by the final year). In summary,all
but one of our estimates indicates that MBO
firmshave higherexpectedperformanceimprove-
ments than controlfirms.Because these estimates
are not consistentlysignificant,we conclude that
there is only weak evidence that the differencein
differences estimator overstates the true MBO
effect and that the differencein surprisesestima-
tor offers an improvementover the differencein
differences.
B. Choosing an Estimate
The tests reportedabove indicate that conven-
tional measuresof the effect of restructuringon
performance embody restrictions that the data
sometimes reject. The pattern of test results
guides our choice of estimates, presented below.
Table 3 reportsmedian MBO effect estimates as
well as Wilcoxon tests of the hypotheses that
these effects are zero. Our finding of positive
expected improvementsat restructuringfirms-
and concomitantrejectionof hypothesisA-sug-
gests that the raw changes (1) gives larger esti-
mates than the restructuringsurprises (2). Re-
sults in table 3 confirmthis. With the exceptionof
the COMPUSTATestimate for the first post-
buyoutyear, all of the restructuringsurpriseesti-
510 THE REVIEW OF ECONOMICS AND STATISTICS

TABLE 3.-MEDIAN ESTIMATES OF THE MBO EFFECr

USING ALTERNATIVE ESTIMATORSa

Control N lb 2C 3d 4e

1. COMPUSTAT data used to forecast expected performance

t+ 1 35 4.1 5.7 6.8 6.7
(1.97)9 (0.95) (1.39) (1.97)9
t+ 2 31 11.9 7.4 11.5 11.8
(2.62)9 (1.87)h (2.00)9 (2.36)9
t+ 3 14 22.8 18.1 33.6 26.9
19.4 10.2 28.7 22.7
(2.42)9 (1.66)h (2.86)9 (2.17)9

2. Value Line data used to forecast expected performance

a. Individual firms
t+ 2 25 18.0 7.7 21.4 15.7
(2.65)9 (0.98) (1.98)g (2.19)g
t+ 3 11 23.9 1.4 33.9 33.1
(2.31)9 (0.80) (2.13)h (2.84)9
b. Industry aggregate dataf
t+ 2 24 13.1 12.0
12.4 7.5
(0.71) (1.31)
t+ 3 10 21.0 28.7
4.6 23.1
(1.38) (1.17)
a Wilcoxon statistics are in parentheses. Critical values for two-tailed tests are 1.96 and 1.65 for 95% and
90% significance levels, respectively.
bRaw changes: X~t+k -t. All measures are reported as percentage change in the ratio of operating income to
sales.
c Restructuring surprise: Xt+k - E(XR+k It).
d Difference in surprises: [XjR+k- E(X!Rklt)] - [Xt+k - E(Xt+klt)].
Difference in differences: [XI k -Xt ]-[Xt+k - X].
Note that since there are an even number of firms in this panel and in year t + 3 of panel 1, there is no unique
median, so we report both medians. Columns 1 and 2 are blank for this panel because these estimators are based
only on restructuring firm data.
g Significant at 95%.
h
Significant at 90%.

mates are smaller and less significantthan the
medianrawchanges.For example,the rawchange
in the operating income to sales ratio for the
median firm is 11.9%for the sample of 31 firms
with COMPUSTATdata in the second post-
buyoutyear. Adjustingthese figuresfor time se-
ries forecasts of expected performanceyields an
increase in the ratio of just 7.4%. While perfor-
mance improvementspersist even after removing
expected improvementsat restructuringfirms,we
rejectthe hypothesisthat these improvementsare
zero with less confidencethan for raw changes.
The result of hypothesis B, that control firms
experienced negative performanceshocks, indi-
cates that the difference in surprises estimates
should be larger than the restructuringsurprise
estimateswhich ignore these shocks.Again table
3 is consistentwith our earlier findings.In every
instance, median differencesin surprisesexceed
restructuringsurprisesand are more significant.
For example, the median restructuringsurprises
in the second post-buyout year are 7.4% and
7.7% (using COMPUSTAT and Value Line fore-
casts, respectively),while the associated median
differencein surprisesare 11.5%and 21.4%.
Finally,we compareour theoreticallypreferred
set of estimates,the differencein surprises,to the
differencein differencesapproachcommonlyused
in the literature.The estimates differ when ex-
pectationsof future performanceat restructuring
and control firms diverge. The positive and sig-
nificant performanceimprovementsexpected at
MBO firms (documented above) are somewhat
offset by the expected changesin performanceat
control firms. As a result, the medians of the
difference in differences and difference in sur-
prises are in most cases quite similar,even though
we sometimes reject hypothesis C, that the ex-
pected changes at restructuringand controlfirms
are identical.
The reader may find it puzzlingthat although
in some cases we reject hypothesisC, the median
estimates of (3) and (4) are virtually identical.
The answer relates to the distributionof differ-
ences in expected performancechanges for both
types of firms in this sample. The adjustments
 RESTRUCTURING AND CORPORATE PERFORMANCE
(which distinguishbetween estimators(3 and (4))
are close to zero for firms near the median for
estimator (3) and more substantialin the tails.
Hence, the mediansare virtuallyunaffectedwhile
the significancelevels drop somewhat.
In summary,our best estimate of the MBO
effect leads us to conclude that there are large
positiveincreasesin the ratioof operatingincome
to sales after the buyout. This measure of per-
formance improves by 6.8% between the last
pre-buyoutyear and the first post-buyoutyear.
Performanceimprovementsby the second post-
buyout year range from 11.5% to 21.4%. Our
estimatesof performancein the thirdpost-buyout
year indicateimprovementsof up to 20%to 30%.
The median ratio of operatingincome to sales in
the last pre-buyoutyear is 10.6%. Therefore a
10%improvementin performancecorrespondsto
a post-buyoutoperatingincome to sales ratio of
11.7%.Given a medianpre-buyoutsales figureof
$570 million, this improvementtranslates to an
increasein operatingincome of about $6 million.
If MBOs improveperformanceby, say, 30% over
longer horizons, and if these improvementsper-
sist, then the presentvalue of the firm'sincreased
operating income would be $180 million (dis-
counted at 10%).
VI. Conclusion
Recent developments have focused attention
on the difficult question of whether corporate
restructuringaffects performance.The principal
obstacle to measuringthe effect of restructuring
on performance is accounting for what would
have happenedto performanceif the reorganiza-
tion had not occurred.Existingstudies have gen-
erally measuredthe effect as the change in per-
formanceat the restructuringfirm,less the change
in performanceat a control firm.
We have shown in this paper that this conven-
tional measurementapproach is one of various
special cases of a more general measurement
framework. Moreover, the restrictions on the
general frameworkrequiredto justify the use of
each special case are testable. Using data on
MBOs, we test and sometimes reject these re-
strictions,suggestingthat more flexibleestimators
of the MBO effect may be preferable to more
commonlyused estimators.
511
The results of our hypothesis tests guide our
selection of MBO effect estimatorsand estimates.
Even though we find some evidence that our
estimatorprovidesan improvementover the con-
ventional approach, our best estimates of the
MBO effect lend added supportto the view that
MBOs enhance operatingperformance.
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