Corporate Restructuring and Industrial Research and Development (1990) / Chapter Skim
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Evening Session, October 11, 1989
Evening Session, October 11, 1989
Pages 1-20
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We therefore established the Academy Industry Program, which is the National Research Council's official liaison to American industry.
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since 1985. He has shared responsibility for regulating this nation's securities markets during what has obviously been their most tumultuous period in recent memory, with the crash, the insider trading scandals and the growth of sophisticated institutional investment instruments.
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The privilege is particularly great because it affords an opportunity to consider a topic of substantial national concern: the relationship between America's research and development efforts and the growing wave of restructuring activity now sweeping our corporate sector. It probably comes as little surprise that hordes of critics stand ready to condemn corporate restructuring in the United States as bad for workers, harmful to local communities, damaging to U.S.
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Viewed from the corporate boardroom, our comparative situation may not be much better. Although corporate spending on R&D climbed steadily at an inflation-adjusted rate of 5.8 percent per year in the decade preceding 1986, aggregate corporate spending on R&D has slowed substantially since 4 See A
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For purposes of the present analysis I am focussing on nondefense RED because it is unlikely that restructuring activity has a meaningful effect on defense R&D spending levels. In addition, nondefense R&D expenditures are more directly related to the economy's international economic competitiveness than military R&D expenditures.
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Recent estimates by staff of the Federal Reserve Bank of New York are truly frightening.~3 After adjusting for inflation, tax rates, and other factors, the New York Fed study suggests that in 1988, the average annual effective cost of capital in the United States for a benchmark R&D project was 20.3 percent. The cost of capital in West Germany for the same benchmark project was 14.8 percent, and in Japan it was only 8.7 percent.l4 Thus, capital for R&D purposes is now more than twice as expensive in the United States as in Japan.
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markets and strike at those economic factors. The most recent evidence suggests that our capital costs are higher than Japan's predominantly because our savings rate is lower and because we have less macroeconomic stability as reflected in the volatility of price levels and interest rates.~9 at 78.
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THE SECTORAL INCIDENCE OF RESTRUCTURING ACTIVITY If corporate restructuring activity truly has a major impact on aggregate R&D expenditures, we would expect to find that corporate restructuring occurs with some frequency in industries that engage in significant amounts 20High capital costs imply a greater scarcity value for capital. This higher price of capital suggests that the market will be less tolerant of managements that fail to earn adequate returns.
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As explained by Professor Lawrence Summers of Harvard University, Governor Dukakis's chief economic adviser during his recent presidential campaign, "impost LBOs occur in mature industries that do not spend a lot on research, so there is not yet much evidence to support claims that R&D is severely cramped by LBOs."2t Indeed, most restructuring takes place in industries that are not R&D intensive, so the point extends beyond simple LBO transactions.22 This observation can be made much more simply: Bloomingdales didn't do much R&D before its takeover and it hasn't done much R&D since. The same holds true for takeovers, buyouts, and restructurings involving companies like Beatrice, United Airlines, Stop N' Shop, Allied Stores, Avin, Storer Cable, Columbia Pictures, Burlington Industries, and hundreds of others engaged in non-A&D intense lines of business.
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Thus, the image of America's R&D leaders as being under the restructuring gun appears to be at odds with at least one large and inconsistent fact: The companies feeling the heat from restructuring activity appear to be those that have failed to invest as much in R&D as their industry counterparts not the other way around. R&D CHANGES AFI ER RESTRUCTURING Having established that the bulk of restructuring activist occurs in industry segments that are not R&D intensive, and that the targets of restructuring activity tend to do less R&D than their industry peers, a 25L.
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NSF/Census survey of industrial R&D."3i In earlier research the same authors found that R&D employment does not change following restructuring, even though there is a substantial decline In nonproduction employment, that is, of managers and administrators who work at corporate headquarters.32 Similarly, Bronwyn Hall examined all takeovers of publicly traded manufacturing firms between 1976 and 1986 and concluded that the data "provide very little evidence that acquisitions cause a reduction in R&D spending." In the aggregate the firms involved in mergers were in no way different in their pre- and postmerger R&D performance from those not 29 See, e.g., Statement of Dr. Julie Fox Gorte, project director, Office of Technology Assessment, Before the Subcommittee on Science, Research, and Technology, Committee on Science, Space, and Technology, U.S.
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completed between 1977 and 1986, finds a "substantial increase in profitability following the MBo."34 She concludes, however, that these increased profits are apparently not due to "pervasive cutbacks in 'discretionary expenditures' such as maintenance and repairs, advertising, or R&D which might lead to a longer run decline in cash flows."35 In particular, Smith finds that the "median ratio of R&D expense to sales increases from .012 in the year preceding the MBO to .018 in the year following the MBO, with a median change of 0.00 for the seven firms with available data."36 Moreover, there is anecdotal evidence that R&D expenditures may actually increase in some situations following a takeover or restructuring. For example, after Hoechst's purchase of Celanese Corporation, R&D spending increased by 10 percent annually.37 Data prepared by Kohlberg, Kravis & Roberts, America's leading leveraged buyout firm, also confirms that R&D expenditures decline prior to leveraged buyouts and suggests that KKR, at least, budgets for aggregate increases in R&D expenditure.38 On the other side of the ledger, however, stands a recent NSF study that examined R&D expenditures at the 200 largest it&D-performing firms in the United States.39 These firms account for almost 90 percent of industrial R&D spending in the United States.
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Conglomerate acquisitions are, however, quite different from current restructuring efforts, and many of the factors that caused conglomerate acquisitions to fail provide incentives for current restructuring activity. See also, Porter, From CompeictiveAdvantage to Corporate Strayer, 64 Harvard Bus.
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One of the consequences of restructuring is typically a downsizing of the firm's scale as it focuses on more profitable market niches. Thus, in order to compare the NSF results with prior research, it may be necessary to recalculate the NSF findings in terms of research intensity.46 A second potential explanation of the reduction in aggregate expenditures is, as the NSF study itself notes, that "firms may simply be eliminating duplication and inefficiency within their R&D programs."47 Here, there is at least some anecdotal evidence supporting the view that postrestructuring reductions in aggregate outlays do not necessarily imply a weakened R&D initiative.
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THE STOCK MARKET AND R&D EXPENDITURES But how do we tell "smart" R&D from "dumb" R&D? The short answer Is that there is no easy answer.
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While this simple comparison of Merck and General Motors is not enough to sustain any broad hypothesis about stock market behavior, it is enough to force critics of takeovers to take pause and to reconsider some 53See, e.g., the materials cited in notes 1 and 2, supra. 54The World's loo Largest Public Companies, Wall SL J., Sept.
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The market did not penalize du Pont with a decline. Similarly, a study by SEC economists found that a sample of 62 R&D announcements were associated with significantly positive stock price returns.6i A study of the stock price effect of 658 announcements of changes in planned corporate capital expenditures also found that announcements of increased capital expenditures are correlated with significantly positive stock price effects while reductions in capital expenditures are correlated with declines.62 No doubt, these average statistics mask significant mistakes on both sides of the R&D fence.
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Nonetheless, Unocal's management pumped enough money into this project both taxpayer dollars and shareholder dollars that its expenditures substantially depressed its stock price and became a major magnet for Boone Pickens's attempted takeover of the company.66 64See Investment Dealers Digest, Oct.
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Most fundamentally, America needs to increase its savings rate so that more domestic capital is available for R&D and for other investment projects. On a more targeted basis, R&D tax credits and reduced capital gains tax rates can also help lower the effective cost of capital for R&D projects.
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20 CORPORATE RESTRUCTURING smart R&D. This is charity R&D that does a disservice to the corporation, to its stockholders, and to its scientists who won't be able to do future R&D for that company unless it starts earning some profits from its past R&D efforts.
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