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The OM Scott And Sons Company Leveraged Buyout Case Solution

Solution Id Length Case Author Case Publisher
2014 1504 Words (5 Pages) Toby Stuart Harvard Business School : 190148
This solution includes: A Word File A Word File

On 31st December 1986, the assets of Scott were sold to Scott managers and a private firm, Clayton and Dubilier (C&D), through a leveraged buyout. Clayton and Dubilier believed that managers require a personal interest or stake in the heightened value of the firm, due to which they encouraged managers to purchase equity through their own money. The compensation and remuneration plans for managers at Scott was also changed to enhance the base salaries of managers. The managers were also incentivized through bonus plans that allowed them to earn 30% to 100% of their base salaries as their bonus, based on their position across the organizational hierarchy and their performance. Bonuses given out by ITT were much lower and had very minimal variance as compared to the current bonus schemes. Clayton and Dubilier also paid higher base salaries to employees, and the top ten managers were compensated almost double of what they were being given by IT. The targets of each employee were decided by the employee and their supervisor before the beginning of the year. The buyout was quite like a management buy-in as employees were given much higher autonomy, control, and regulatory authority, which they were deprived of before. Clayton and Dubilier played a supporting role in their ownership as they tried their best to support and empower the management by enabling decentralized decision-making across all levels of the organization.

Following questions are answered in this case study solution

  1. How did the leveraged buyout change the way Scott was managed? 

  2. What are the important characteristics of the "rules of the game" at Scott after the buyout?

  3. What did Clayton & Dubilier contribute to the Scott organization? 

  4. If you were Timnick, would you be worried about whether you had adequate control over Scott’s managers? 

  5. Did being highly leveraged hurt Scott’s competitive position? 

  6. What do you think Clayton & Dubilier’s plans are for Scott?

Case Analysis for The OM Scott And Sons Company Leveraged Buyout Case Solution

2. What are the important characteristics of the "rules of the game" at Scott after the buyout?

The organization initially had a very stringent, formally centralized organizational structure comprised of Scott managers exhibiting depressed levels of autonomy as they required formal approvals and permissions before undertaking major actions. However, the post-buyout scenario resulted in a more decentralized organizational structure as Scott managers now exhibited higher levels of decision-making authority without prior permissions being required. A novel compensation plan for the managers allowed higher incentives for managers as a reward for improved performance measures on their part. It largely comprised of augmenting base salaries for managers and bringing managers within the financial folds of management equity ownership. A newly approved bonus plan also allowed them to earn 30% to 100% of their base salaries as bonuses, depending on their organizational rank and performance. The leveraged buyout resulted in 91% of Scott's capital structure, comprising of debt that was characterized by restrictive covenants associated with economic transactions, financial activities, and mandatory accounting-based requirements. With regards to the economic activities, only obsolete assets worth less than $500,000 to be sold, and three-quarters of the sale amount must be used to repay debt in a prioritized manner. Capital expenditures were limited to specified dollar amounts each year; the organization had an outstanding debt. Changes in the corporate structure were mostly prohibited. With regard to the financing activities, the issuance of additional debt was capped at strict dollar values with only certain kinds of debt being allowed for a certain specified dollar value. The payment of cash dividends was also mostly forbidden for the organization. With regard to accounting requirements, specific values were denoted for adjusted net worth, interest coverage, current ratio, and adjusted operating profit, majorly as a result of bank-based prohibitions. Other major restrictions prevailed with regards to investment and production policies that relied on the approval of respective lenders. Consent was required to purchase or sell assets and to merge or create subsidiaries.

3. What did Clayton & Dubilier contribute to the Scott organization? 

Clayton and Dubilier (C&D) saw the greatest value in Scott from the start, due to which they agreed to pay $200 million and placed the highest bid from the pool of eight competing bids. They restructured the capital structure of Scott, which now had 91% debt, primarily through bank debt. They also raised $20 million through selling Scott equity. Clayton and Dubilier executed a new remuneration plan for its managers, which encompassed inflated base salaries, higher bonus incentives, and ownership of shares by the management. They believed that managers will truly give their best performance if they have a personal stake within the firm value, and hence, they encouraged managers to purchase equity in Scott company through their personal funds. The Scott managers also had higher levels of control and decision-making authority now, and it did not require approval from supervisors like they did before. This decentralized structure contributed to enhanced motivation and employee performance, such as higher inventory turnovers signifying better inventory control. They also induced an organizational culture shift that was more accepting of managers taking control and exhibiting ownership of the company. Clayton and Dubilier also placed an efficient board and executive committee in place to oversee, monitor, and supervise the management and organizational performance.

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