Spin-offs can profit parent companies at a price to managers and employees

Merger mania and a bigger-is-better mentality largely rule the business world, but sometimes the exception — spin-offs — provide an alternate path to prosperity if the organization can weather the storms of such a radical change. Among the keys to spin-off success are supportive management and flexible employees, according to Kevin Corley, a management professor at the W. P. Carey School of Business. "Two words help us understand why spin-offs occur: money and flexibility," Corley says. The biggest reason for spinning off part of a company into its own independent entity is that there is an opportunity for the owners and/or shareholders of the parent company to realize a monetary gain through the spin-off.

Merger mania and a bigger-is-better mentality largely rule the business world, but the exception — spin-offs — provides an alternate path to prosperity if the organization can weather the storms of such a radical change. Among the keys to spin-off success are supportive management and flexible employees, according to Kevin Corley, a management professor at the W. P. Carey School of Business.

From fast food — McDonald's recently spun off the Chipotle Grill, to communications — the Baby Bells spun from AT&T are investment legends, spin-offs can be more agile in navigating turbulent markets.

"Two words help us understand why spin-offs occur: money and flexibility,"

Corley says. "The biggest reason for spinning off part of a company into its own independent entity is that there is an opportunity for the owners and/or shareholders of the parent company to realize a monetary gain through the spin-off."

Chicago-based Spin-Off Advisors reports there were 27 spin-offs estimated at $55 billion in 2005 and that there have been 344 spin-offs worth about $1.3 trillion in the past eight years. Although a large company enjoys economies of scale, a vast distribution network and a large customer base, Corley says, smaller companies can more nimbly enter and leave markets, respond to customer demands and introduce new products or services that may cut against "the traditional way" of an industry or service.

"Spinning part of a company off so it is better positioned to take advantage of these 'small is flexible' advantages can actually help the larger organization refocus on what it does best, while possibly still reaping the advantages of the spun-off company's successes through strategic partnerships and equity-based relationships," Corley notes.

But a spin-off can put managers and employees through the wringer, says Corley, an expert on the internal change processes.

"How employees feel about the spin-off largely has to do with how the need for the spin-off is framed for them by management and whether they see benefits for themselves arising from the spin-off," Corley says. "If the spin-off is framed as necessary because their unit is underperforming and becoming a drag for the parent company, then employees may feel they are being 'thrown to the wolves' for the sake of the organization that is shedding them.

"Alternatively, if employees believe the spin-off is best for their unit and will result in something they see as valuable — for instance, freedom to pursue more interesting strategies, autonomy from an overbearing parent company, increased payouts from stock options, etc. — then they are likely to look at the extra work and responsibilities of being independent as worthwhile, at least initially."

In a 2004 study called "Identity Ambiguity and Change in the Wake of a Corporate Spin-off," Corley and Dennis A. Gioia, a professor of organizational behavior at the Pennsylvania State University Smeal College of Business, make it clear that spin-offs require planning, effort and much readjustment. The study says spin-offs can take years to accomplish and cites "change overload" and "identity ambiguity" among the dangers. Identity ambiguity is defined as "a collective state wherein organization members found themselves without a good sense of who they were as an independent organization during and after the spin-off or a sense of what the future held for them as an organization."

The transition is a crucial period of uncertainty. Company insiders become outsiders. Investors, analysts, the media and customers don't always understand what is going on. A Goldman Sachs study of 10 major U.S. companies that split from 1994 to 1999 — including Lucent spinning from AT&T and Nabisco spinning from RJR Nabisco Inc. — found the average company's shares fell 6 percent between the announcement and the split and before the spin-offs proved to be profitable. Shareholders may sell because the company is no longer what they originally bought into — a "you're not the person I married" effect — or because they just don't want shares in a smaller enterprise.

Management should make sure that what the company says internally matches what is being said externally; the company also should move quickly to correct inaccurate media reports, the Corley-Gioia study says.

"When outsiders' perceptions of the organization differed from insiders' perceptions, members questioned both their beliefs about who the organization was and their status as members of the organization," the Corley-Gioia study states. "Ambiguity about identity is uncomfortable, at both the individual and organizational levels, and most would like to resolve it quickly to achieve some renewed semblance of clarity about their identity."

Change overload has a bruising effect on a practical, everyday basis, Corley says of the study's findings.

"During a spin-off, most people in the spun-off organization have two to three times the amount of work stress they had before; first, their regular job responsibilities still need to be completed, but with increased stress due to the need to establish financial stability and competitive prowess quickly," he says. "Second, all of the organizational changes taking place to make the spin-off itself a success will add an extra layer of stress to employees already feeling pushed to the limit."

How can supervisors best support employees involved in a spin-off?

"Supervisors who realize the potential for this 'change overload' early and act on it often — through actions such as increased communication about changes, formal and informal stress-relieving activities, maintaining employee morale within work teams — will go a long way in helping their employees make it through the stress associated with the spin-off," Corley says. "We also know from several studies of organizational change in general, that getting employees involved in decisions affecting their jobs will help them feel more committed to the change and more likely to go the extra mile to make the change effective."

Employees should be fully informed about the company's new identity and branding during the spin-off process, and employees' suggestions for "adaptive changes" to their jobs and work teams should be heeded by managers, Corley says.

"The collective sense-making that ensued in the wake of this identity ambiguity fostered the creation of a change context in which defining who the new organization was and where it was going became a strategic imperative for the ultimate success of the spin-off," the study states.

Given the right environment and effective management, most any type of employee can succeed in a spin-off and make it work, Corley says.

"Those employees best suited for a spin-off are those that can handle uncertainty and ambiguity, are willing to step up and play a leadership role when necessary, and are comfortable with adapting to changes in their environment," Corley says. "Employees who exhibit these characteristics are often labeled 'entrepreneurial' because of their propensity to also be creative and/or innovative. But an entrepreneurial spirit is not necessarily best during a spin-off, because the organization needs team players and employees who are committed to the company."

Are cash/stock bonuses part of the motivational picture in making a spin-off work?

"Often stock bonuses are; but interestingly, they also often end up de-motivating employees for two reasons," Corley says. "First, most spin-off situations involve regulations stating that a certain amount of time after the spin-off must pass before employees can sell the stock options they've been granted. This period of time often coincides to the 'honeymoon' period immediately following the spin-off when the stock does well, regardless of the spin-off's performance. By the time employees are free to sell their stock, the stock price has come back to reality and, unfortunately, is often below the option price employees were able to buy the stock for.

"Second — and this is true for employee stock options in any organization, not just spin-offs — employees often find that their performance in their job has little to no effect on the company's stock price. They see their individual performance increase, their division/department performance increase, maybe even their company's

performance increase, but the stock price declines because of factors outside their control, such as world events, interest rate changes, political decisions, competitor moves etc."

Corley says that any reward that is not tied directly to an employee's performance can de-motivate the employee because they don't receive the reward although they achieve the desired performance.

"Thus, if management does want to use a financial incentive during or after the

spin-off, it needs to be one that is tied directly to something in the control of the employee, or else the motivation attempt could end up having the opposite effect," he says.

Does the "subtractive change" of a spin-off sometimes hurt the parent company?

"It can, especially in one intriguing way: through a 'brain drain' from the parent company," Corley says. "Often, a unit that is slated to be spun off will attract the

best and the brightest from the parent company because of the promise of autonomy and independence, not to mention that chance to be involved in the start of something potentially big."

If the parent company loses a lot of its institutional knowledge and skills to the spun-off company, Corley says, "It could end up affecting their ability to maintain competitiveness post-spin."