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A Resource Based Interpretation of Performance Enhancing Capital Structure Changes : The O.M. Scott LBO Revisited

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  • Peter Wirtz

    ()
    (Finance Magellan - Équipe de Recherche en Finance - Université Jean Moulin - Lyon III - Centre de recherche Magellan de l'IAE)

Abstract

The O.M. Scott case study published in 1989 in the Journal of Financial Economics has come to be a classic in illustrating the plausibility of some fundamental concepts that underpin mainstream models of the efficiency attributes of capital structure in modern corporate finance. In these models, high leverage traditionally appears as a strong incentive to refrain from sub-optimal investment behavior by self-interested managers. Thus reducing managerial agency cost has been considered as an essential driver of enhanced value in much of financial modeling. In the present paper, we attempt a somewhat different, albeit complementary, mainly resource based interpretation of the very rich empirical material contained in Baker and Wruck (1989). In fact, a close reading of the case suggests that the observed significant increase in operating performance post-LBO was to a great extent the consequence of the yet unexplored cognitive changes implied by switching dominant shareholders. Namely, we find that value at O.M. Scott was essentially increased by (1) a significant reduction in what may be termed cognitive agency costs while (2) the new dominant shareholder contributed substantial cognitive value by stimulating and advising a dynamic learning process leading to enforced managerial capabilities, especially with respect to more effective routines of cash management.

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Paper provided by HAL in its series Post-Print with number halshs-00746277.

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Date of creation: 08 Jun 2005
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Publication status: Published - Presented, FMA European Conference (Financial Management Association), 2005, Siena, Italy, Italy
Handle: RePEc:hal:journl:halshs-00746277

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Keywords: capital structure cognitive agency costs cognitive value managerial agency costs;

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  1. Baker, George P. & Wruck, Karen H., 1989. "Organizational changes and value creation in leveraged buyouts : The case of the O.M. Scott & Sons Company," Journal of Financial Economics, Elsevier, Elsevier, vol. 25(2), pages 163-190, December.
  2. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, American Economic Association, vol. 76(2), pages 323-29, May.
  3. Thomas Hellmann & Manju Puri, 2002. "Venture Capital and the Professionalization of Start-Up Firms: Empirical Evidence," Journal of Finance, American Finance Association, American Finance Association, vol. 57(1), pages 169-197, 02.
  4. Alchian, Armen A & Demsetz, Harold, 1972. "Production , Information Costs, and Economic Organization," American Economic Review, American Economic Association, American Economic Association, vol. 62(5), pages 777-95, December.
  5. Luigi Zingales, 2000. "In Search of New Foundations," Journal of Finance, American Finance Association, American Finance Association, vol. 55(4), pages 1623-1653, 08.
  6. Jay B. Barney, 1986. "Strategic Factor Markets: Expectations, Luck, and Business Strategy," Management Science, INFORMS, INFORMS, vol. 32(10), pages 1231-1241, October.
  7. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 3(4), pages 305-360, October.
  8. Armen A. Alchian, 1950. "Uncertainty, Evolution, and Economic Theory," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 58, pages 211.
  9. Richard N. Langlois, 1994. "Cognition and Capabilities: Opportunities Seized and Missed in the History of the Computer Industry," Industrial Organization, EconWPA 9406003, EconWPA.
  10. Stulz, ReneM., 1990. "Managerial discretion and optimal financing policies," Journal of Financial Economics, Elsevier, Elsevier, vol. 26(1), pages 3-27, July.
  11. Demsetz, Harold, 1988. "The Theory of the Firm Revisited," Journal of Law, Economics and Organization, Oxford University Press, Oxford University Press, vol. 4(1), pages 141-61, Spring.
  12. Wruck, Karen Hopper & Jensen, Michael C., 1994. "Science, specific knowledge, and total quality management," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 18(3), pages 247-287, November.
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