Three forms of restructure

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    Management
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THREE FORMS OF RESTRUCTURE

Table of Contents

THREE FORMS OF RESTRUCTURE 1

1.0 Introduction 3

2.0 Expansion 4

42.1.0 Mergers and Acquisitions

2.1.1 The Rover-BMW Case 5

2.2.0 Joint Ventures 7

82.2.2 The Philips-Whirlpool Case

93.0 Contraction

3.1 Sell-offs 9

3.2 Spin Off 10

3.3 Equity Carve-Outs 11

3.4 Divestitures 12

4.0 Changes in ownership 13

4.1 Privatisation 13

4.2 Leveraged Buyout 14

5.0 Recommendations and Conclusion 15

References 17

Three Forms of Restructure

1.0 Introduction

Corporate restructuring as mentioned by Marimuthu (2009, p.123) is without a doubt becoming a major program for scores of organizations since it allows for cost-effectiveness and greater efficiency. Basically, both business and corporate strategies are presently included in the restructuring program so as to yield better financial performance both in long and short run. Corporate restructuring framework involves creating new ownership (equity carve-outs, split-ups and spin-offs), assets reorganization (sell-offs and acquisitions), reorganisation of financial claims (leveraged recapitalization, exchange offers, liquidation as well as financial reorganization) in addition to other strategies such as joint ventures, leveraged buyout (LBO), and so forth. The objective of corporate restructuring is to respond to a crisis or to take part in the pre-emptive plan of the company for survival reasons. The process of restructuring is a painstaking and prolonged one; thus, it involves a number of challenging undertakings and needs analysis of both costs and social benefits. The most challenging task is convincing the affected parties to recognise the reform efforts desirability. Meanwhile, strategic appraisal of downsizing, restructuring and re–engineering policies are considered to be important paradigm of management. The paradigm can be used by corporations to generate competitiveness by completely leveraging their core competences. Marimuthu (2009, p.123) opines that corporate restructuring may be a motivation for organizational change since it is positively related to the long term profitability of the company. Substantial upsurges in market shares and reduction of cost is mostly associated with from restructuring. Before restructuring as it will be evidenced by a number of case studies in the essay, companies should first understand their industrial structures that are continuously changing. Furthermore, innovative approach is required during restructuring so as to inaugurate a feasible competitive advantage. Generally, restructuring can be seen as an expansionary program of the company that involves takeovers, mergers and acquisitions as well as green-field investment. Contractionary program, on the other hand, involves downsizing, divestiture, down-scoping as well as financial restructuring, which is the most common form of restructuring. Financial restructuring evidently encompasses debt or equity restructuring, which directly impact the capital structure. Therefore, Sharma (2005, p.45) posits that debt restructuring is a way of carrying out financial restructuring, and has an effect on the capital structure of the company. The essay critically explains the three forms of restructure; expansion, contraction, and changes in ownership.

2.0 Expansion

One form of restructuring is expansions, which includes mergers, acquisitions, consolidations as well as other activities that lead to expansion of the company or its operations scope.

2.1.0 Mergers and Acquisitions

Mergers and acquisitions have been utilised as a tool for successful restructuring tool in the world of business since 1897. They are considered to be efficient tools that can be used by the management to realise greater effectiveness through exploitation of growth opportunities and synergies. Both Mergers and acquisitions according to Malik et al. (2014, p.522) are the most utilised technique for conducting corporate restructuring bearing in mind that the restructuring entails assets, business and ownership. Mergers and acquisitions can result in change of the company ownership; reorganisation of business in terms of divisions and units, change of management and new ventures diversification; as well as
securitization. The main objective of restructuring is improving the shareholder value. In this case, Merger happens when two or more companies fuse or combine to form one company with a common management and ownership. On the other hand, an acquisition is where a firm is purchased by another firm. Acquisition becomes friendly when the acquiring firm’s management and that of the target firm come up with suitable terms agreeable to both firms. According to Dhingra and Aggarwal (2014, p.817), acquisition is the action of acquiring effective control over management or assets of a firm by another firm devoid of combining companies or businesses. Essentially, corporate restructuring by means of merger and acquisition has become an international issue, but is more prevalent in developed economies. They still play a crucial role in the world, and they are known as techniques for maximising the company’s market share so as to improve profitability and eventually surge the company’s share market value. Furthermore, they offer economical and financial benefits like risk diversification, employment opportunities, economies of scale, equity base improvement, increased share earnings, as well as access to talent (Udoidem & Acha, 2012, p.135). According to Ghosha and Duttab (2014, p.397), mergers and acquisitions enable economies to change competitively amongst alternative organizational structures and management teams for corporate assets’ control. Therefore, they play a crucial role in economic growth leading to enormous gains for the shareholders.

2.1.1 The Rover-BMW Case

. (Cowell, 2000) the acquisition became disastrous due to poor integration planning. The integration plan provided by BMW involved three phase process wherein the first two years were used in offering financial assistance with no integration between the companies. The two companies became fully integrated in 1999. Another problem arose from linguistic differences, whereby BMW’s middle managers and engineers who spoke German were unable to communicate with Rover’s personnel who spoke English. As a consequence, this resulted in communication problem the ultimately hindered the process of integration. Furthermore, business culture of Rover and BMW were significantly different. It seems that BMW had erroneously judged the acquisition soundness anchored on the cost of developing their technologies from scratch. BMW failed to achieve the synergies and lost 2 billion pounds in the process before selling Rover to Phoenix Consortium for only 10 pounds,Still, Rover Company was acquired by BMW AG in 1994 for 800 million British pounds, but after investing approximately 2 billion British pounds and achieving no synergies, BMW sold the company to Phoenix Consortium in 2000 for 10 British pounds. The main goal behind the Rover company acquisition was for the expansion of BMW since the company wanted to improve the spread of its market. BMW had considered Rover a perfect deal since Rover has had some considerable cost advantages because of its close connection with Japanese methods of production. BMW wanted to acquire the 4 x 4 and front-wheel driving technology from Rover since developing the technology as well as the production methods from scratch was exceedingly high. Another reason for acquisition was because of the low cost level in the British manufacturing sector than in Germany since it was 60 per cent cheaper in Britain; therefore, the acquisition could help BMW reduce the costs of production. Piercy (2008, p.403)Founded in 1878, a British automaker known as Rover Company went through a string of mergers, takeovers, and nationalization before 1968 when it became part of the British Leyland Motor Corporation. In 1988, the group was sold to British Aerospace, six years later the group control was passed to Bayerische Motoren Werke (BMW) AG. According to

2.2.0 Joint Ventures

World markets globalisation has become persistent; thus, forcing many companies to explore as well as develop capabilities to globally distribute or source intellectual property, products or services. Economic downturn has made international alliances to become more attractive since most companies do not have management strength, experience, resources, and infrastructure to penetrate the international markets. According to Kayo et al. (2010, p.401), different forms of business alliances are facilitating companies to access the international markets more effectively and economically. In this regard, a joint venture enables the purchaser to understand the business, which is cannot be accessed by the outsider. In this case, the buyer can evaluate the exact value of the intangible assets like systems, distribution networks, brands and people so as to comprehend how the business operates by getting involved directly for a certain period of time. This enables the buyer not to make uninformed decision. In view of the restructuring challenges that many companies face these days, the managers according to Nanda and Williamson (1995) must first understand the role of joint ventures. A number of companies have exhibited that joint venturing is an important tool for unlocking assets that have been imprisoned in the corporate portfolio. Imperatively, a joint venture offers the restructurer a means to smoothly exit a business and placing more money in the pockets of the shareholders as compared to a complete sale. The joint venture help diminish the risk of the buyer getting a lemon since it makes sure that the transfer of business takes place smoothly devoid of disruption, which is normally related to a straight sale. Traditional joint venture mainly focussed on business expansion, but nowadays is seen as a tool for restructuring. A number of companies such as Corning, Philips, Honeywell, IBM and others have creatively utilised joint ventures so as to exit from non-core businesses.

2.2.2 The Philips-Whirlpool Case

In the late 1980s, Philips decided to restructure its diverse portfolio after recognizing that a major appliances division worth $1.55 billion was nonessential to its future operations. Basically, the appliances division had over nine different brands; therefore, lack of coordination between distribution and sales led to overlaps and inefficiencies. Philips’ operations were haphazardly spread in five countries and its ten plants were urgently necessitating huge injections of capital so as to become world-class facilities. Besides that, the company had over 14,000 employees, and majority of them were protected by European job security legislation. In spite of the abovementioned problems, the company management understood that the assets in the appliances division were valuable, which included underutilized skills in manufacturing; reputable brands; and world-class distribution network. Regrettably, such strengths were weakened by the inability of the division to realize the global scale in components production. On the other hand, Whirlpool Corporation was planning to expand its business operations beyond U.S. base (Nanda & Williamson, 1995). The company valued the benefits associated with take over a major position in Europe. Whirlpool recognized the need to completely change the business’s cost structure so as to source components internationally, coordinated distribution, sales, and production across product lines as well as countries and in order to rationalize production. For this reason, Whirlpool was offered by Philips 53 per cent of the appliances business for a cost of 381 million US dollars together with an option of procuring the remaining 47 per cent within 36 months. The arrangement was without a doubt very attractive for Whirlpool because it offered the company an opportunity of learning about the appliances division reality while inside the business and start improvement plans prior to purchasing the entire division. On the other hand, the joint venture offered Philips an opportunity to demonstrate to the buyer (Whirlpool) that the division was actual valuable. Additionally, in the joint venture the best talent was retained, motivation amongst employees remained constant, and dealers as well as customers remained loyal (Nanda & Williamson, 1995). As a consequence, the joint venture changed the appliance business into a profitable and vibrant venture. For a while, the appliances of Whirlpool were branded as Philips-Whirlpool appliances; thus, enabling Whirlpool to introduce its own brand name gradually in the market using the Philips brand name, which is a reputable brand across Europe.

3.0 Contraction

Another form of restructuring is contraction, which takes different forms such as equity carve-outs, spin-offs, sell-off, divestitures, and so forth.

3.1 Sell-offs

Sell-offs is normally carried out when the subsidiary fails to fit into the core strategy of the parent company. In this case, the market could be devaluing the combined businesses because of insufficient synergy between the subsidiary and the parent. Consequently, the board and management agree that the subsidiary should be sold off. Besides discarding the undesirable subsidiary, sell-offs are also important in raising cash that may be utilised to pay off debt. In the early 1990s, corporate raiders utilised debt so as to finance acquisitions, and after buying they would sell-off their subsidiaries with the goal of raising cash so as to pay the debt. As mentioned by Bergh et al. (2008, p.136), the sell-off reduces the buyers’ abilities to exploit the prospective information asymmetries. Moreover, sell-offs can simulate an auction, whereby the market forces for acquiring assets offsets the abilities of the buying firm to capitalise on the information disadvantages in the managers of the selling firms. Engaging a number of parties competing for the restructured assets can drive the selling price higher and push out managers intending to buy the assets below their market value. Furthermore, the pressures generated by a number of buyers can act as a corrective tool for asset undervaluation because of their value ignorance by the manager of the selling firm. As mentioned by Ushijima and Iriyama (2015, p.74), the process of sell-off can lead to assets reallocation to the most productive and efficient uses and the derived value from the market can surpass the expectation of the management. Sell-offs of unrelated and secondary business assets assist in mitigating the the restructuring firm’s knowledge and information disadvantages and results in the maximisation of the financial value through forces of competitive bidding.

3.2 Spin Off

Another type of contraction is spinoff, which happens after the subsidiary becoming an independent entity. In this case, the subsidiary shares are distributed by the parent firm to its shareholders by means of a stock
dividend. In spin-off there is no cash is generated; therefore, spinoffs cannot be utilised for financial deals or growth. Spinoffs in most instances unlock the shareholder value that is normally hidden and enables the parent company to improve its management focus. According to Veld and Veld-Merkoulova (2004, p.1112), investors have to be cautious of throw-away subsidiaries since some are created to off-load debt or separate legal liability. After the issuance of the spinoff to the shareholders of the parent company, a number of shareholders could be lured into swiftly dumping their shares on the market; thus, lowering the valuation of the share. A spin-off as defined by Veld and Veld-Merkoulova (2004, p.1112) is a pro-rata shares distribution of a company’s subsidiary to its shareholders, where no cash transaction happens. In U.S., most of the spin-offs announcements are strongly related to abnormal returns ranging between 1.32 per cent and 5.56 per cent. According to Kim (2011, p.41), firms with higher information asymmetry levels demonstrate higher abnormal returns during the period of announcement. A good example is the Chugai’s Reactive Spin-Off with the goal of avoiding anti-trust issues.In this case, Chugai Pharmaceutical as well as Nippon Roche merged as a subsidiary wholly-owned by Roche Pharmholding; therefore, Chugai’s parent became Roche in October 2002. Before the merger took place, Chugai had decided on a spin off Gen-Probe, its wholly-owned subsidiary in the United States and finalised the Gen-Probe shares distribution to Chugai’s shareholders in September 2002. The spin-off objective according to Kimura et al. (2004, p.22) was to prevent anti-trust problems over the merger; therefore, Chugai resolved to spin-off by means of capital reduction (Kimura et al., 2004, p.22). Therefore, all the Chugai’s shareholders were allocated 0.086 shares in Gen-Probe for every Chugai’s share.

3.3 Equity Carve-Outs

Another form of contraction is the equity carve-out, which according to Kimura et al. (2004, p.20) is the sale of the subsidiary equity interest through private or placement initial public offering (IPO). Equity carve-outs can be categorised into two forms: majority carve-outs and minority carve-outs. The majority carve-out is a case where the majority interest in a majority-owned or wholly-owned subsidiary is sold to the investors. The minority carve-out takes place when a minority interest in a majority owned or wholly-owned subsidiary is sold by the parent company to investors ; thus, retaining the majority interest. Basically, minority carve-outs are considered beneficial because the parent company is still in control of the subsidiary. However, this can result in conflict of interests’ problems with the subsidiary’s minority shareholders. Furthermore, a minority carve-out can lessen the flexibility needed by the subsidiary and parent to capture synergies. On the other hand, majority carve-out is considered beneficial because it generates significant cash for the subsidiary and/or parent and enables the parent to lay off its obligation to the subsidiary. In a majority carve-out the possibility of conflicts of interests between the subsidiary and parent is very low, but both the parent and the shareholders can fully participate in the subsidiary upside. The parent normally loses the control over the subsidiary following the majority carve-out. PTM (parent company) in March, 2000 formed PTMultimédia.com (PTM.com) to manage its Internet-related businesses. Carve-out of PTM.com happened in June 2000, and the sales of the shares was achieved through primary offer limited to PTM.com (subsidiary) and PTM (parent) shareholders, after which Portugal Telecom (PT) together with PTM jointly retained a 91.05% majority shares of the subsidiary (Padrão & Farinha, 2006, p.10). Seven months following the carve-out, PTM decided to reacquire PTM.com and because of disagreements with the minority shareholders, PTM.com stay in the Portuguese Market ended in 2002.

3.4 Divestitures

Divestiture is the most common form of contraction used by restructuring firms since it involves selling some percentage of the company’s assets to a third party. The sold assets could be a product line, subsidiary, or division. After selling the assets, the seller normally gets cash, but every now and then they also receive securities or both. The earnings from the sale are normally invested back to the remaining business or shared to the company’s claim holders. Even by getting rid of a certain percentage of its assets, the selling firm remains the same as before. However, the tax liability to divestitures is normally substantial. Divestiture is common in the U.S.; for instance, companies in 2011 had announced almost 3,000 divestitures valued at 320 billion US dollars. According to Eckbo and Thorburn (2013, p.166), the deal value for 30 per cent of the transactions was more than $100 billion, while for 2.5% transactions was more than 1 trillion US dollars. Even though both buyers and sellers seem to benefit from the divestiture, the total gains division relies on the two parties’ relative bargaining strength. Furthermore, the value creation depends on the divestiture successful completion. Still, the positive returns announced by buyers and sellers show that divestitures normally generate value. Some executives do understand the value of a well-planned divestiture program. Eckbo and Thorburn (2013, p.167) asserts that managers can utilise divestiture to rejuvenate as well as strengthen their companies by looking beyond the stigma presently related to selling off businesses. For instance, divestiture was the basis of General Electric (GE) strategy, under the leadership of Jack Welch. As GE’s CEO, Welch had in the first four years divested 117 business units, which accounted for 20 per cent of GE’s total assets (Dranikoff et al., 2002). Other CEOs who have used divestiture technique include Sandy Weill who made 11 noteworthy divestitures in the 1990s while at Travelers Group; former Pactiv CEO, Richard Wambold who sold six businesses (between 199 -2010) to invest in high-growth opportunities as well as strengthen the balance sheet of the company; and former PerkinElmer CEO, Greg Summe who utilised both acquisitions and divestitures to entirely reshape the company, thus, transforming the company into an innovative ultramodern company (Dranikoff et al., 2002).

4.0 Changes in ownership

Another form of restricting normally utilised by many corporations is change of ownership through privatisation, Leveraged Buyout (LBO), and so forth.

4.1 Privatisation

Privatization as mentioned by Goodman and Loveman (1991, p.26) has turned out to become an international phenomenon and takes place when the public sector production activity is transferred by government to the private sector. Privatisation is normally used in restructuring the public sector and is considered important because it improves efficiency and proper use of resources. Hitherto, a number of privatisation has taken place; for instance, the Central Electricity Generating Board (CEGB) was privatized and restructured in 1990. Basically, CEGB restricting involved dividing the company into four successor companies, whereby the general public bought three of them; thus, generating a power pool as well as liberalising the entry into the market (Newbery & Pollitt, 1997, p.1). The three companies included the National Grid that bought the high-voltage transmission network and PowerGen and National Power both of which were allocated the thermal generating plant. The other successor was the Nuclear Electric that was allocated the nuclear power stations. Some years after the restructuring some changes were observed; for instance, the labour productivity doubled in the successor companies and there was a noticeable shift toward natural gas rather than coal. The switch to gas from fossil fuels resulted in a significant decline in emissions of nitrogen oxides, carbon dioxide as well as sulphur dioxide, which normally result in global warming and acid rain. The privatization came with some costs; for instance, the shift towards gas resulted in coal industry decline. As a result, employment of coal miners dropped from 250,000 miners in 1985 to merely 7,000 in 1994. This resulted in the privatisation of the coal industry in late 1994 (Newbery & Pollitt, 1997, p.3).

4.2 Leveraged Buyout

Leveraged buyout (LBO) can be defined as restructuring of the company’s ownership and capitalization using debt as the main technique of financing the restructuring. Leveraged buyout normally takes place for a number of reasons; tax benefits, managerial incentives, cost savings, reducing the number of owners, control, and flexibility. Nowadays, buyout is mainly pursued by upper management in the publicly held firms, in what is referred as management buyout (MBO). In LBO, there are always winners and losers; for instance, the current shareholders whose shares are bought in the buyout are normally the big winners. This is attributed to the fact that LBOs involve premium payment over the market price whereupon the shares were trading before the takeover notice. In the same way, the parties that take the control of the firm after buyout achieve managerial control as well as the greater flexibility usually related to private companies. The firm new owners can as well access the cash flows and assets of the firm that were previously part of the public organization. In LBO, the main losers are the existing creditors of the firm since the buyout is mainly financed with debt capital; therefore, the bondholders are now considered to be creditors of the riskier firm. As a consequence, outstanding
bonds market value is driven down making the future paying of debt more unclear. In the 1980s, firm managements that were subject to MBOs were sued by some institutional investors that had large bond positions within those firms. According to the institutional investors, the managers knowledgeably involved the company in activities that damaged their economic investment as the corporation’s creditors. Such suits led to damage awards and settlements in a number of instances. An example of LBO is the one that occurred in 2007 when Texas Pacific Group and Goldman Sachs’s (GS) handpicked Alltel Corp
for approximately 27.5 billion US dollars. The Alltel leveraged buyout is considered to be one of the largest buyout in the United States telecommunication space. After the buyout, Alltel was subsequently sold to Verizon Wireless for a profit (Sorkin & Holson, 2008).

5.0 Recommendations and Conclusion

In view of the above discussed case studies, it is evident that there are a number of errors that companies should avoid during the process. One of the classic errors made by many companies is changing the organisational structure in large steps and rarely instead of incrementally so as to meet changing necessities. Another error that should be avoided is managing the restructures in a manner that alienate employees; thus, living the clients suspicious. Basically, by accepting that employees have enormous emotional investment within the organisation, then the managers can almost certainly avoid backlash. Besides that, the company must be prepared sufficiently for negotiation since the process of restructuring is, essentially, a negotiation process. Before initiating a negotiation, the management team should have clear strategy with regard to:  non-negotiable and negotiable issues as well as difficulties that could come about during the process. Imperatively, the company should prepare a credible and coherent business plan so as to improve the firm’s liquidity. In conclusion, the essay has critically explained the three forms of restructure; expansion, contraction, and changes in ownership. As mentioned in the essay, the main objective of corporate restructuring is to improve the firm’s long-term survival by means of greater cost-effectiveness and efficiency. Restructuring enables companies to adjust their capital structure given that there is need for changes on their equity proportions or their debt proportions. As mentioned in the essay, for companies to realize value-building growth, they have to create and sustain balanced business portfolios. The essay has focussed on three forms of restructuring: expansion (Mergers and Acquisitions as well as Joint Ventures); contraction (equity carve-outs, sell-offs, spinoffs and divestitures); and changes of ownership (privatisations and leveraged buyouts).

References

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