How has the housing bust and accompanying recession impacted the mobility of homeowners? Are divestitures always a smart move for companies? Can multinationals create a fact-based case for the real economic impact of their investment in different countries? Professors Joseph Gyourko, Emilie Feldman and Ethan Kapstein, respectively, examined these issues — and what they mean for business and consumers — in recent research papers.
Why ‘Underwater’ Homeowners Are Staying Put
The ability and willingness of Americans to pull up stakes to pursue opportunity in a new hometown is an economic hallmark of the United States. Yet the lingering economic malaise leaves many Americans trapped “underwater” in homes worth less than the mortgage owed, reducing mobility and contributing to the nation’s stubbornly high unemployment rate.
Wharton research shows that mobility drops 30% for homeowners with negative equity in their properties, and each additional $1,000 in mortgage or property tax costs cuts mobility by 10% to 16%. “We looked into the effects on mobility, and they appear to be pretty large,” says Wharton real estate professor Joseph Gyourko, author of the recent paper, “Housing Busts and Household Mobility: An Update,” along withWharton real estate professor Fernando Ferreira and Joseph Tracy of the Federal Reserve Bank of New York.
Building on 2010 research, the authors’ latest work adds data from the most recent American Housing Survey (AHS) conducted by the U.S. Census Bureau for the Department of Housing and Urban Development (HUD). The new data allowed the researchers to study the effects of declines in housing prices between 2005 and 2007 on people relocating between 2007 and 2009, which provided a glimpse of how mobility patterns were impacted by the global economic recession. The latest paper also takes a closer look at whether moves documented in the study were permanent or temporary, and restricts the sample to instances where it was immediately clear that a household stayed put over the long term or owned a home for a time before moving out for good. However, the paper acknowledges that because of uncertainties in tracking home transactions and residency, “we cannot really know for sure how the recent housing bust impacted permanent mobility until a few years into the future when the data will reveal the true nature of those transitions.”
The Census Bureau has released data showing that the number of Americans changing their address is at its lowest point since the government began tracking this statistic in 1948. U.S. mobility peaked in 1951 with about 21.2% of the population moving, the Census Bureau reported. That figure remained stable at around 13% for years, but fell to 11.6% — or 35.1 million people — in the year ending March 2011, according to an Associated Press analysis of Census data.
The Wharton research shows that “people will stay in a house a long time even when they have negative equity,” Gyourko notes. “That’s the problem,” he adds, emphasizing that the reluctance to move is contributing to higher unemployment rates. Gyourko says there are many reasons a homeowner will stay in a house, even if it might make more sense to get out and move on to find a new job in an area where there are more prospects. “Maybe they like the school district or other good things in the community. Or they don’t want to take the hit to their credit if they default.” Moreover, he states, many people feel a “moral or ethical duty” to make good on loans they promised to pay off.
In order to help revive the anemic economy and spur job creation, the Obama administration has announced plans for a new program to aid homeowners who are “underwater” on mortgages. The plan would allow homeowners to refinance at today’s lower rates and reduce monthly payments. The program would be available only to homeowners whose mortgages were made before June 1, 2009, and are owned or guaranteed by Fannie Mae and Freddie Mac. An estimated one million borrowers would be eligible, but housing officials acknowledge the assistance would reach only a tenth of homeowners in trouble.
Gyourko doubts that lower interest rates will be enough to revitalize the market. “When you get overleveraged it’s hard to get out, absent some form of debt forgiveness. It just takes time.”
The Wharton research paper suggests that future work be undertaken to investigate the correlation between housing and employment patterns. “The likelihood that labor markets deteriorate along with housing markets raises the possibility that owners with negative equity are not moving in part because there are no good job opportunities elsewhere for them,” the paper states. “Until we address this issue, we will not know the true social cost of highly leveraged home purchases that are more likely to lead to negative equity situations.”
The Dos and Don’ts of Divestitures
When it comes to academic research on divestitures, the message has been that they are usually a smart move for companies. But Wharton management professor Emilie Feldman wondered if the story was that simple. How could all divestitures be positive?
While the benefits and costs of acquisitions have been well explored, the downsides of divestitures have received little scrutiny, Feldman notes. So she zeroed in on one type of divestiture — that of a firm’s original “legacy” operation — and set out to examine whether companies that divested their legacy businesses performed worse, due to the historical importance of these units, than firms divesting other businesses. Her findings, contained in a recent paper titled, “Selling Your Heritage: The Causes and Consequences of Legacy Divestitures,” supported this intuition: Firms that divested legacy businesses saw a decline in operational performance, while those that divested non-legacy units did not.
For her research, Feldman studied a group of 300 diversified U.S. firms. Using sources like corporate annual reports, she identified what the legacy business was for each of those 300 firms — the original business the company operated in at the time of its founding. Feldman then gathered data on all the divestitures made by these companies between 1980 and 2000, including which firms had sold their legacy businesses. Of these 300 firms, 56 divested their legacy businesses.
For the companies that divested their legacy businesses, average return on sales (ROS) for the three years following these divestitures was significantly lower than it had been before the divestitures. By contrast, those which shed non-legacy units had no analogous drop in ROS. Relative to firms which held on to their legacy businesses, the companies that shed these units had a 38% lower return on sales in the three years following the divestiture, underscoring the operational challenges of dumping a legacy business.
What is behind this hit to operations? Feldman’s work identifies two culprits. First is the fact that the value of a firm’s legacy business is often underestimated by its management. That value, which includes things like the degree of customer connection to the legacy unit or the way a legacy business helps maintain a company’s reputation, is often intangible. As a result, firms may not clearly understand what they are giving up, she says. At the same time, divesting a legacy unit can disrupt internal synergies or connections within companies, also causing a hit to operations. “Because legacy businesses constitute companies’ historical cores, the synergies between the legacy business and other parts of the company are likely to be particularly strong,” Feldman points out.
These issues are ones that many large U.S. businesses continue to grapple with. Take the case of Netflix, which announced this fall it would split its video streaming and legacy DVD delivery services into two businesses. Customers reacted negatively to the idea, many dropping their subscriptions altogether, and Netflix was ultimately forced to back-peddle on its decision. Then there is the aborted spin-off by Hewlett-Packard of its personal computer business. CEO Leo Apotheker had announced that HP was planning to spin off the low margin operation, but the company reversed course after it hired Meg Whitman to replace Apotheker in October. Among the problems was the degree to which the remaining HP businesses were tied to the PC operation. HP estimated the spinoff would have boosted annual costs by $1 billion due to the loss of procurement and branding opportunities associated with the unit. And shedding the PC business would have triggered a one-time expense of $1.5 billion, as HP would have been forced to create separate IT, support and other functions for the PC spinoff.
Feldman’s work shows that both Netflix and HP may have been wise to cancel their proposed legacy divestitures. “The negative operational consequences [of legacy divestitures] is worse when the legacy unit is more connected to other businesses within the company, when it contains more intangible resources and when it constitutes a larger portion of the parent company’s assets,” she notes.
The research raises some tantalizing questions. A critical one: Is the lag in operating performance among companies which divest their legacy businesses reflected in their stock market performance? In the year after divestiture, market performance is higher for firms which divest legacy units than for those which hold onto their legacy businesses, which Feldman believes may be a favorable response to these companies’ very rational reasons for divesting their legacy businesses. In many cases, firms reallocate resources away from slow-growing legacy industries in favor of faster-growing new business lines. “Often these legacy businesses are not very attractive and may be seen as holding the company back,” she notes.
The longer-term implications of legacy divestitures for stock market performance, beyond the one-year time frame her paper examines, is a subject for future research, though Feldman notes that anecdotal evidence points toward eventual challenges for those firms divesting legacy businesses. At the same time, she also hopes to explore what steps might help firms divesting a legacy unit minimize the operational hit. It may be that certain management tactics, including setting a very clear vision for the company’s future and creating discipline around company strategy, may help firms boost post-divestiture performance.
Corporate Contribution: Measuring the Economic Impact of FDI
When it comes to making the case for how they have helped the nations in which they operate, multinational corporations have typically fallen short. Wharton visiting professor of management Ethan Kapstein argues that instead of touting steps like creating foundations to help alleviate social ills, corporations should make a fact-based case on what their investment has meant to the economy in those nations.
In a recent study titled, “The Socio-Economic Impact of Newmont Ghana Gold Ltd.“, along with a number of similar previous projects for firms like Unilever, Standard Chartered Bank, SabMiller and others, Kapstein used a carefully honed methodology to assess how the firms have impacted local economies. “Governments and NGOs are not satisfied with these [corporate social responsibility reports featuring only] smiling photos of a school or concert supported by a multinational,” says Kapstein, a professor of political economy at INSEAD. “They want data.”
In the case of Newmont, Kapstein himself doubted he would find that the company’s mining operations in Ghana had a major economic impact on the nation. “I said, ‘We can look at this, but there isn’t going to be much impact,’” Kapstein recalls. “It’s a bunch of guys from Denver who come and dig a hole in the ground and leave.” But he found that Newmont’s Ghana operations accounted for nearly 10% of the nation’s exports, 4.5% of its total foreign direct investment and 1.3% of GDP. Even more striking was that directly and through spinoff jobs spawned by its presence, Newmont created 48,000 jobs in Ghana.
The level of Newmont’s impact was not due to good luck. In 2006, the company created a program in conjunction with the International Finance Corporation, an arm of the World Bank, aimed at cultivating a network of local suppliers. Called the Ahafo Linkages Program, it works with businesses in the Ahafo Brong region of Ghana where the mine operates. The area grapples with significant challenges, including high poverty rates and low literacy levels. Prior to opening the mine, Newmont had to relocate and compensate some 1,700 households and build new homes and schools for those that were displaced. The Ahafo Linkages Program was aimed at cultivating not only mining related businesses in the area, but also non-mining enterprises. According to Kapstein, the program has yielded a tangible payoff. “I met one local entrepreneur who showed up at the mine to help clear land [early on],” he notes. “Now he has moving equipment and 100 employees. He’s just a great entrepreneur. It is one thing after another like this. The program has generated huge results.”
To document those impacts, Kapstein and Rene Kim, a partner at Netherlands-based consulting firm Steward Redqueen, came up with an intricate formula. They used the input-output tables published by the government in Ghana to sort out Newmont’s economic contribution. The tables track the economic value of what goes into the economy — labor, materials like steel, etc. — and what comes out in the form of products or services. Then they looked at Newmont’s income statement and traced it through these tables. In the end, the researchers were able to calculate both the firm’s contribution to employment in Ghana and its contribution to the nation’s GDP. The employment numbers include the firm’s direct hiring as well as the spin-off jobs created by suppliers. The GDP contribution includes the consumer spending produced by those jobs, corporate taxes paid and the firm’s profits in the country. “We essentially drive the company through the economic map of the country,” Kapstein says.
Historically, countries and foreign investors have had on-again, off-again relationships, making it critical for firms to understand their impact on local economics, Kapstein notes. “The companies provide investment and technology, and the view was that this would lead to growth. But empirically, it was hard to show that happened…. And in some cases, these companies were bringing labor or environmental practices that weren’t popular. So in one country after the other, the foreign direct investment would be contested, and we would have waves of nationalization. I would say to CEOs, ‘Eventually, this will boomerang, and you will have to make your case.’”
Understanding the full range of impacts a firm is having in a market can and should impact decisions on where companies source their raw materials and other inputs, Kapstein states. “Right now, executives typically go to the Internet and find the cheapest supplier. But they need to think about the value of local support and the cost of that lost support,” he says. “If you want to build a factory or launch a new product, you need a constituency to support that. And those local suppliers are critical constituents. The fact is that local sourcing may be more valuable.”
A close look at the economic impact of a company’s operations in international markets can also shed light on some previously unknown opportunities. In 2009, Kapstein helped Standard Chartered Bank assess its impact in Ghana. The bank was taking heat from the business press, as well as some local groups, which contended that the institution was financing only global companies and big projects like the country’s offshore oil fields. Kapstein’s work, however, showed that the bank was also providing key funding to Ghana’s small- and medium-sized business sector. The study also revealed that the small-and medium-sized business sector was very efficient in Ghana, a fact that prompted Standard Chartered to redouble its efforts there. “This was counterintuitive and a surprise to all of us,” Kapstein notes.
Kapstein’s analysis does not factor in the negative impacts that corporations may have in some of these countries, such as pollution or issues with occupational safety. But Kapstein notes that many of those impacts are well documented, while less light has been shed on positive contributions. “Of course there are negative impacts,” he says. “But most of the reporting on FDI tends to be negative. This information shows the tradeoffs and enables meaningful debate to occur. You need to have that debate in light of the facts.”