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Reprinted from Navigator Volume 1, Number 4, December 1997
Albert J. Dunlap has received considerable attention, and criticism, for his dramatic restructuring of the Scott Paper Company in 1994-95, his outspoken advocacy of shareholder rights, and his current efforts to restructure and rebuild Sunbeam Corporation. For the same activities, Dunlap has drawn the admiration of Objectivists and libertarians.
Frank Bubb, a member of IOS's Advisory Board since its inception, was a senior attorney with Scott Paper in Philadelphia when Dunlap was hired as that company's chief executive officer in April 1994. Over the next year and a half, Bubb witnessed and was involved in Scott's restructuring and subsequent merger into Kimberly-Clark Corporation. As it happens, Bubb was not only well positioned to observe Dunlap's activities but well qualified to evaluate them, having previously written in defense of shareholder rights and corporate takeovers. An excerpt from his 1986 Freeman article, "Hostile Acquisitions and the Restructuring of Corporate America" is reprinted on page 10 of this issue.
Currently, Bubb is Vice President, General Counsel and Secretary of Fort Lauderdale-based The Sports Authority, Inc., the nation's largest full-line sporting goods retailer, a position he has held since February 1996.
Navigator: Al Dunlap's restructuring of Scott Paper Company has been widely viewed as one of the most dramatic and deepest in corporate America. At the time, it received extensive media coverage for its alleged harm to Scott employees and communities, usually juxtaposed with references to Dunlap's large compensation package. Can you give us an overview of the key events during that period, from your perspective?
Bubb: Al Dunlap was hired as Scott's CEO on April 19, 1994, when Scott's market capitalization was about $2.8 billion. By June, eight of the company's eleven senior executives had been terminated or resigned and Dunlap had hired three new executives, all of whom had worked with him in prior restructurings. In mid-August, Dunlap began implementing the restructuring with a downsizing of over 11,000 employees, or over one-third of Scott's worldwide total. The 72-percent downsizing of corporate staff (including twenty-one of the twenty-six in the Law Division in which I worked) occurred with breathtaking speed: most of those cut were gone within a week or two. Shortly after the downsizing, Dunlap made "mega" stock option grants to everyone in middle management and above, and structured the options so that exercisability would be accelerated on a change in control of the company.
Next, Dunlap turned to selling non-core assets. The largest was S.D. Warren Company, a coated-paper operation that constituted about a third of the total business and had essentially no synergies with the larger tissue business for which Scott was known. Negotiations to divest Warren culminated in a sale agreement in early October; the sale was closed in mid-December for $1.6 billion. A whole series of non-core assets were sold during late 1994 and early 1995: the three-building corporate headquarters, energy generation facilities, health-care and food-service businesses, a hunting lodge and related real estate. During the same period, Dunlap accelerated or commenced tissue joint venture efforts in China, India, and Brazil, and brought in a new marketing team and advertising agency to enliven Scott's line of tissue products.
In November, Dunlap's team began working with the investment banking firm of Salomon Brothers to locate potential acquisitions or potential acquirors, and Salomon contacted numerous companies—including Kimberly-Clark—to explore a transaction. In early 1995, Dunlap began efforts to divide the headquarters into a small "worldwide" headquarters and the "North American" headquarters, and announced in March that the worldwide headquarters of about seventy people would be established in Boca Raton, Florida (where Dunlap had lived before joining Scott). In early April, Scott and Kimberly-Clark began discussions on a merger, and in early June both companies began working full tilt on the transaction. The Boca headquarters was opened on July 5. The merger agreement became final and was publicly announced on July 17, and the merger was consummated on December 13. By the merger date, Scott's market capitalization had increased to $9.0 billion. Most of Scott's remaining corporate staff—including all attorneys—were terminated by Kimberly-Clark before the end of January 1996.
Navigator: What was the situation at Scott when Dunlap arrived, from both a business and a morale standpoint?
Bubb: Scott had undergone two "restructurings" in the three years before Dunlap arrived. In retrospect, these efforts largely failed to remedy Scott's fundamental problems: the staff continued to be overpopulated with bright people endlessly seeking consensus among themselves; the company had hemorrhaged capital to support marginal projects such as massive investments in S.D. Warren at the height of the paper cycle and a food-service business that had been a major strategic blunder; Scott's marketing of its core tissue products was lackluster; the few really promising projects—such as the new tissue mill in Owensboro, Kentucky, and entry into China—proceeded at a measured pace. These ongoing problems, combined with the failure of piecemeal "restructuring" efforts, had generated cynicism and resignation among the headquarters staff.
Navigator: But didn't prior management develop a comprehensive restructuring plan? According to a January 15, 1996, Business Week article,
What galls many former executives, employees, and union leaders is their belief that Dunlap and his team took credit for improvements that had been in the works for months, if not years. Scott's board of directors began to consider the $1.6 billion sale of ... S.D. Warren Co.—which Dunlap himself calls 'the linchpin of my strategy'—in the spring of 1993, a full year before Dunlap arrived.
Bubb: This critique is substantially true, but it misses the point. Prior management had finally realized the magnitude of the problem and over an extended period had developed a plan to restructure the company and cut 8,300 jobs over a three-year period. The plan required three years to implement fully in part because of some elaborate sequencing involving the creation of satellite paper-converting facilities that would have made the production process still more complex. In addition, prior management's plan had less than total credibility among employees. Based on the extended implementation period and their experience with prior "restructurings," many employees clung to the belief that they personally could escape a new restructuring's effects.
Dunlap was not a grand innovator. He took the prior restructuring plan, cut out its complexity, increased its scope, and pushed the button to make it happen all at once. On the sale of Warren, the phrase "began to consider" exemplifies the problem. Prior management operated by consensus and thus they always "considered." They were just implementation-challenged.
Navigator: What was the reaction at Scott's headquarters when Dunlap's appointment was announced?
Bubb: Sheer panic. Within hours, copies of articles about his prior stints with troubled companies were circulating around the building. It was the same theme over and over again: cut staff quickly, sell non-core businesses, move the corporate headquarters, then sell the company. The names "Chainsaw" and "Rambo in pinstripes" preceded him into the building. When he arrived, and then when he sacked eight of eleven senior executives within six weeks, he had total credibility among the headquarters staff. If there was even one employee who did not do some serious work on his or her résumé during that period, I would be surprised.
Navigator: In his book, Mean Business (Times Books, 1996), Dunlap states: "The restructuring must be done within the first twelve months." Why is speed so important?
Bubb: I think Dunlap was very perceptive on this point—unlike the majority of CEOs who attempt restructurings. There are some interesting parallels between the recent restructuring of many American corporations and the efforts to restructure former communist economies. Free market economists such as Friedrich Hayek have advocated "shock therapy," and indeed that is the title of the second chapter of Mean Business.
The benefits of "shock therapy" in both contexts are similar. Potential sources of opposition are kept off balance and are less able to stall the process or cut their own special deals. The credibility of those implementing the restructuring is maintained, and thus yearnings for the status quo ante are not allowed to be viewed as realistic. The pain of the transition, while more intense, is shorter because malinvestments are liquidated and all participants are given immediate incentives to act in value-creating ways. By contrast, a more gradual transition with intermediate phases encourages participants to make (monetary and psychological) "investments" in such phases which become unsustainable as soon as those directing the restructuring decide to move to the next phase. A more gradual transition thus encourages the development of constituencies for each intermediate phase, which may then act to derail movement to the next phase.
A lot of the media criticism of Dunlap was based on the implicit premise that it is more humane to transform a business slowly, to give employees time to adjust. But a slow restructuring is ugly for those involved—lying awake nights worrying; commiserating with friends, neighbors and relatives; deferring the purchase or renovation of a house; politicking in the office. Dunlap did not come across as a humanitarian, but he emphasized to employees that a quick, one-time restructuring would allow everyone to get on with their lives.
Navigator: According to Business Week, "Dunlap cut plenty of muscle along with the fat—pumping up short-term results at the expense of long-term health." Can you comment?
Bubb: Dunlap apparently bought into the muscle-versus-fat dichotomy, insisting in Mean Business that he cut only fat. In fact, there is no clear dividing line between muscle and fat. The number of employees who can handle a given function depends crucially on their willingness to make decisions and be held individually accountable, their expertise and judgment, and their ability to set priorities.
At the time of Dunlap's cuts, I—and everyone I discussed it with—thought Dunlap had cut too deeply. In retrospect, I think the cuts were about right, even though, paradoxically, Scott could not have continued indefinitely to be staffed at those low levels.
Deep cuts—combined with strong incentives such as Dunlap's "mega" option grants—force changes in behavior among the survivors that milder cuts would not. Radically cutting the number of people in all staff functions simultaneously means that staff people are giving each other less work. You don't spend time "touching base" with people because they are no longer there. Within your area of responsibility, you have to make decisions and implement them with a minimum of oversight. You have to set priorities rigorously, focusing on only the most important matters and letting the rest slide. In short, deep cuts and stronger economic incentives force an organization to function entrepreneurially rather than bureaucratically. After an understaffed organization has learned to function entrepreneurially, selective additions can be made of newcomers who absorb the new culture. In Scott's specific case, additions were already being made when the announcement of the merger with Kimberly-Clark froze the process.
Prior management knew Scott needed staff cuts and tried to go about the process by first deciding what work no longer needed doing, then cutting staff to fit the work. Dunlap's counterintuitive approach—cut staff and the work will shrink—turned out to be far more effective.
Navigator: In Mean Business, Dunlap said the move from Philadelphia to Boca Raton was made "to break the back of Scott's plodding, consensus-driven corporate culture." If his considerations were strictly business, why did he return to the town he had just left? And why was the move made in the midst of active efforts to sell Scott?
Bubb: In my view, the move to Boca was Dunlap's only significant decision which did not enhance shareholder value. Scott's "plodding, consensus-driven culture" was dead before the move. It unquestionably made sense to move the small remaining staff out of the three-building campus near Philadelphia, and if Dunlap had intended for Scott to remain an independent company, a theoretical case could have been made for splitting the "worldwide" and "North America" staffs. However, it cost millions of dollars of shareholder money to start up a 70-person worldwide headquarters in Florida. And for what? The personnel mix at the Boca headquarters was less than optimal because several key individuals simply refused to move from Philadelphia. The Boca headquarters was doomed before it opened and was shut down by Kimberly-Clark soon after the merger.
Navigator: How did you and the other Boca Raton employees react to news of the merger with Kimberly-Clark?
Bubb: Just about everyone expected Dunlap to sell the business within a year or two, but not many expected it so soon. When I was told a month before the move to start working on the merger—having already deeded our house in Swarthmore to the company and committed to buying a new house in Boca—my wife and I went through several days of bitterness and rebellion toward Dunlap before deciding that the financial incentives made it worthwhile for us to ride this to the end. When the merger agreement was announced at the Boca headquarters less than two weeks after it opened, I watched the faces of my colleagues, most of whom had families and household goods in transit from Philadelphia. The sense of betrayal—of having been used—was palpable.
Navigator: Did the merger between Scott and Kimberly-Clark make sense?
Bubb: Absolutely. For years, people at Scott had noted the complementarity of the two companies, both in terms of types of products and areas of strength around the world. Of all the possible transaction partners for Scott, KC made the most sense. All it took for a transaction was for one set of executives to be "selfless" enough to give up their control of a major corporation.
Navigator: Throughout Mean Business, Dunlap makes much of the "shareholder versus stakeholder" controversy. Could you describe these two positions?
Bubb: The shareholder view is that corporate management is the agent of the corporation's shareholders and is thus legally and morally obligated to act on their behalf. With a few minor deviations, this has been the traditional position of corporate law in the United States. The stakeholder view is that shareholders are only one "constituency" of corporate management and that management must satisfy several other constituencies, including employees, customers, suppliers and the communities in which the corporation's operations are based.
The stakeholder view gained adherents in reaction to the wave of hostile takeovers in the 1980s. Hostile takeovers evolved out of the marketplace as a means of reasserting shareholder control over corporate managements. (See box below). The stakeholder view found ready acceptance among those who felt threatened by hostile takeovers, including employees threatened with downsizings, unions threatened by newly aggressive cost-cutting managements, communities where corporate operations were closed or charitable contributions were curtailed, and—not surprisingly—it found acceptance among incumbent managements under attack.
Navigator: Did the shareholder versus stakeholder controversy arise at Scott before Dunlap arrived?
Bubb: Yes. The utility of the stakeholder viewpoint was not lost on Scott executives who wished to protect themselves from a hostile takeover. In 1987, Scott's general counsel asked for my comments on a draft bill he was preparing to have introduced in the Pennsylvania legislature. Entitled the "shareholder protection act," it expressly permitted management to consider the interests of corporate "constituencies" other than shareholders in considering how to respond to a takeover bid, thus overturning longstanding precedent. This provision and others in the draft bill practically required incumbent management's consent for a takeover to proceed.
Navigator: How did you respond?
Bubb: I returned the draft with a terse handwritten note, observing that granting incumbent management the power to make economic decisions affecting thousands according to some subjective weighting of the conflicting interests of groups constituting "the public" would invite our society's ultimate arbiter of "the public interest," the government, to step in and dictate such decisions. Ultimately, the "shareholder protection act" became law, placing Pennsylvania in the forefront of the late 1980s trend toward protecting incumbent management from shareholders.
Navigator: You refer to "the conflicting interests" of groups of stakeholders. Do you think these conflicts are inherent, and if so, how would you resolve them?
Bubb: The conflicts of interest are not inherent, but are manufactured by the viewpoint that sees people through a narrow prism that focuses on only one aspect of their relationships to others rather than in their full role as members of a society. If one views a person only as an employee of corporation X facing a layoff to enhance returns for X's shareholders, then one has created a conflict that does not exist in reality, because that person has an overarching interest in living in a society where his own freedom of contract and private property rights are secured under a stable legal system. If one needs any empirical support for this assertion, one need only look at how over the past decade the United States, with only partial freedom and labor mobility, has outdistanced Continental Europe and Japan, whose corporations are paralyzed by obligations to a variety of "stakeholders."
This answer by itself does not explain why shareholders should have primacy over other "stakeholders," however. One could imagine a system, for example, in which all business organizations were owned by their employees (as law and accounting firms often are) and in which "shareholders" had no more legal rights than holders of subordinated debt. Starting from a point where employment and ownership roles were bundled, I suspect the results would be sufficiently poor in most cases that employees would sell their ownership roles to others, thus creating shareholder-owners in the traditional capitalist sense. One could attempt the same thought experiment with other stakeholders (communities, suppliers, and so forth), but the results would be even worse. The crucial point is that the legal system must unambiguously define and protect ownership rights, and then let the market decide whether and how ownership roles should be combined with other roles.
Navigator: How important is the "shareholder versus stakeholder" controversy?
Bubb: It is crucial to the survival of capitalism, even in its current mixed form. Communism and socialism have reached their well-deserved destination on the "ash heap of history." Those who adhere to the principles underlying these discredited positions have been casting about for other vehicles to achieve their objectives within a nominally capitalist framework. Their most prominent vehicle has been, of course, the more extreme variant of environmentalism. Now, following in the footsteps of incumbent corporate managers, they are coming to recognize the utility of stakeholder-ism as a means of achieving their ends.
Navigator: In Mean Business and in several of his television interviews, Dunlap advocated paying corporate directors in shares rather than cash. In your experience, is that the right approach?
Bubb: Yes. To ensure that corporations remain private institutions, every possible method of aligning the interests of corporate directors and officers with the interests of shareholders should be pursued. When Dunlap joined Scott, only one other major company, The Travelers Group, paid its directors solely in stock. Dunlap instituted this practice in July 1994 and quickly became its most visible public spokesman. Largely as a result of his efforts, changing the mix of director compensation toward stock has become "politically correct" within the corporate governance community.
Navigator: From your description of him so far, it seems that Dunlap consistently favored a free market economy. Did he take any actions antithetical to freedom?
Bubb: Dunlap actively sought and received subsidies from governments in both Florida and Delaware for the relocation of the worldwide and North American headquarters to those jurisdictions. Shortly after the merger with Kimberly-Clark was announced, Palm Beach County demanded its money back, on the eminently sensible ground that Scott would not be creating the jobs it had promised. Dunlap refused, leaving the mess for Kimberly-Clark to clean up.
Dunlap got it right when he justified cutting Scott's charitable contributions to zero: "But that money is not mine to give. I have no right to give away a shareholder's money." How, then, does he justify taking money from the taxpayers of Palm Beach County and elsewhere?
Navigator: In July 1996, Sunbeam Corporation announced that it had hired Dunlap as its new CEO. The August 5, 1996, Business Week then ran an article entitled "Dear Al: Put Away the Chainsaw," in which two commentators gave Dunlap a little advice: "Everyone expects you to cut jobs, divest assets, then ditch the company at a tidy profit, but Sunbeam is your chance to prove you can manage a company over the long haul." Your comment?
Bubb: So many misconceptions are packed into that article that I hardly know where to begin. Let me start with the idea that different businessmen have different mixes of skills. Some are best at starting up companies, and are widely known and admired as entrepreneurs. (The cultural shift from vilification to admiration began with Ayn Rand.) Some are best at running organizations already intact, and some (but very few) are best at restructuring organizations that have grown fat and lethargic. While the public generally understands the value created by businessmen in groups one and two, apparently not even Business Week commentators understand the value created by those in group three. Their critique of Dunlap, in essence, is that he is not in group two.
To understand the value created by restructurers, let's assume they didn't exist. Corporations would continue on autopilot until they crash, that is, go bankrupt. They would continue to employ and underutilize hundreds or thousands of people who could produce more elsewhere. They would hold assets that would have higher value in the hands of others. Restructurers are entrepreneurs, but with a reverse twist. Instead of perceiving that resources controlled by others would have higher value in their own hands, they perceive that some of the resources they control would have higher value in the hands of others—and they understand what resources they need to keep to have a viable business.
The market understands the value of restructurers, even though most commentators and the public do not. That is why Scott's stock rose from $38 when Dunlap was hired to a split-adjusted $120 at the merger with Kimberly-Clark, and why Sunbeam's stock has almost quadrupled since he was hired. The commentators who assert that Dunlap created no value at Scott think, in effect, that they are more astute than the investors who looked at the same facts and voted with their own money.
Lastly, I think this analysis of the economic role of restructurers provides an answer to all the public tut-tutting about the $100 million Dunlap earned from his twenty months at Scott. Put simply, he earned an entrepreneurial profit, owing to the shortage of competent restructurers. If there were more inhabitants of this niche of the economic ecosystem, Dunlap's return would have been lower; Scott's board could have hired him or an equivalent in exchange for fewer stock options. If the critics want Dunlap to earn less in the future, they should wish for many more who do what he does.
Navigator: How has the whole experience with Al Dunlap affected you personally and your former colleagues at Scott?
Bubb: At the time, the experience was both very difficult and often exhilarating. There was a good deal of bitterness among my colleagues who were let go in the first downsizing, even though the overwhelming majority of them eventually landed on their feet. Among those who survived the downsizing, there was a sense of accomplishment for having hung in there and kept things operating with a fraction of the resources we had before.
There was also a subtle change in perspective which did not become apparent until the Scott people began receiving their first contacts from their counterparts at Kimberly-Clark. Because of its superior products, Kimberly-Clark had never experienced the type of downsizings that Scott had been conducting for over a decade. Its corporate staff consisted of a huge number of very bright, nice people always seeking consensus and the proper approvals. Many of the Scott people took one look and concluded "there's no way I'm going back to that." Shortly after the merger, a remarkably high proportion of the people on Scott's staff had moved into executive-level positions in smaller, more entrepreneurial businesses.
This interview was conducted for Navigator by IOS editorial director Roger Donway.