JOURNAL OF

BUSINESS
STRATEGIES

Old Main

Center for Business and

Economic Research

Sam Houston State University

Vol.1 No.1 Spring 1984
Journal of Business Strategies

Published semiannually by the

Center for Business & Economic Research
Sam Houston State University
Huntsville, Texas

Dr. Elliott T. Bowers

President

College Of Business Administration

B.K. Marks
Dean

Center for Business & Economic Research

William B. Green
Director

Editorial Committee
William B. Green, Chairman
Susan Simmons William Kilbourne
Carol Sangster Nelson Thornton
Sarah Hart
 Editorial Review Board

To ensure that articles appearing in the Journal of Business Strategies are

consistent with the goals of the Journal, an Editorial Review Board referees
all manuscripts submitted for publication. The current members of the
Editorial Review Board are:

Dalton E* Brannen, University of Louisiana

Russell Briner, University of Mississippi
William B* Green, Sam Houston State University
Ray Guillett,· University of Texas, Tyler
,Sara Hart, Sam Houston State University
Jeff Harwell, Sam Houston State University
Charles Hawkins, Lamar University
Herbert Johnson, Sam HoustOtl State University
William Kilbourne, Sam Houston State University
Paul l..indloff, Sam Houston State University
Janis Monroe, Sam Houston State University
Oris Odorn, University Of Texas? Tyler
RichaId Pitre, University of Houston, Clear Lake
Carol Sangster, Sam Houston State University
Arthur Sharplin, Northeast Louisiana University
Mark Simmons, Sam Houston State University
Susan Simmons, Sam Houston State University
Sammie Smith, Stephen F* Austin State University
Vernon- Sweeney, Sam Houston State University
Nelson Thornton, Sam Houston State University
Gary Williams, University of Texas, Texarkana
 Journal of Business Strategies

Volume I, Number 1 Spring, 1984

CONTENTS

A Managerial Strategy To Reduce Investor

Uncertainty and Increase Share Price 4
John C. Groth and Lyn M. Fraser
Texas A&M University, College Station

Guide For The Development of A

Strategic Plan - 10
James M. Tipton
Baylor University, Waco

Chapter 11: A Tool of Strategic Management 24

Arthur D. Sharplin
Northeast Louisiana University, Monroe

Defining Your Business Mission: A

Strategic Perspective 33
William A. Staples & Ken U. Black
University of Houston - Clear Lake

A Comparison of Strategies for Expensing

Business Property 40
Wallace Davidson & Sharon Garrison
North Texas State University, Denton
 A MANAGERIAL STRATEGY TO REDUCE
INVESTOR UNCERTAINTY
AND INCREASE SHARE PRICE

John C. Groth and Lyn M. Fraser

Departluent of Finance
1'exas A&ivl University
<='o11ege Station, Texas

INTRODUCTION
Maxilnizing the firm/s share value is a common managerial objective. We
accept that objective as the appropriate goal for management, because share
price ellcompasses the nlan,y factors of primary concern to management:
earnings per share, riskiness of various investment alternatives timing of
l

investment returns, dividend policy, and many others. The right decisions
witll respect to such an array of factors yield actions that increase share
value. Knowledge and sensitivity to the guidance offered is important to all
functional areas of management.
The purpose of this paper is to stress the importance of a simple decision
rule regarding investor uncertainty. Actions consistent with the rule will
enhance management's efforts to achieve the firm's goal, maximization of
share price. With that in mind, we outline steps for implementation of the
decision rule. The paper is organized as follows. Part one reviews some
general concepts regarding firm valuation, which serve as a background for
the decision rule. Part two sketches the role that uncertainty plays in the
determination of share price and discusses the causes of investors' perceived
uncertainty. This background leads in part three to the decision rule and the
specific steps tIla! nlanagers can follcJ'A to increase share price. The paper
T

closes with a sllmmary.

I. BACKGROUND
It is important to recall that s,hare \!aluation takes place in the market place
- the world external to the firm. ~rhe n1arket is the true test of the firm's
decisions and actions regarding earnings . in\'estments, financing, dividend
policy, and other factors affecting share price~ It is market participants who
deterlnine the nlarket price of the firm' s stock~ .Although management may
believe the firn1' s stock, is (rver or under valued, share price will change only
if investors change their expectations~
Managements actions are (lnl)T one of the Inany factors i11flut~ncing market
4
participants' perceptions of the firm. To increase share price, managers must
influence investors' expectations concerning the firm. Since investors are
quite astute, creating positive expectations in their minds requires that
management make the right decisions with respect to many dimensions of
investor interest. Those decisions can be categorized in four basic areas.
First, the investment decisions must have expected outcomes that are favor-
able relative to attractive opportunities available to investors elsewhere.
Second! management should seek to' finance the firm in the optional way in
order to lower the cost of financial resources. The clue to the right way to
finance comes from the external parties who provide the financial resources.
Third, they must formulate and institute the appropriate dividend policy.
Finally, they should consider the firm's role in relation to social responsibili-
ties, ethics, and other such items. Correct decisions and diligent attention by
managers to these four basic areas will have a positive impact on share price
and variables such as earnings per share, return on investment, and other
measures of firm performance.
But there is one more essential ingredient if management's efforts are to be
rewarded with an increase in share price. Managers must provide informa-
tion to the marketplace so their actions can be appropriately evaluated.
Certainly management must strive to make and take correct decisions and
actions to have favorable impact on firm performance~ But it is equally
important that investors have the information necessary to form the right
perceptions. Management thus must not only do the right thing- but also
communicate with the marketplace so investors can value the actions.
Needless to say, it is difficult always to recognize and reach the optimal
objectives. Yet the rule offered later in this paper will yield benefits even
when outcomes are less than desirable. Regardless of the investment,
financing, and dividend decisions that have been and will be made in the
future, applying the rule will normally lead to an increase in share value
even given poor decisions and actions. At worst, it will leave the value of the
shares unchanged.
Share price is influenced - other things being equal - by the after tax
package of benefits that investors expect to receive by holding the shares.
Another determining factor, which will now be explored, is the perceived
uncertainty associated with those benefits.

II. UNCERTAINTY
In forming expectations and assessing llncertainty, investors want access
to all relevant information and the proper interpretation of that information.
To a certain extent, management can control both access and interpretation.

Access
First, investors want to obtain the information they need to make sound
investment decisions, and they want it at the same time it is available to
5
other market participants. This is true first because investors like to believe
they are making informed decisions and, second, because the market has
proven itself J'efficient" in quickly reflecting available market price informa-
tion. Consequently, those that receive information first can benefit from that
information, regardless of whether it is "good" or Jibad".
An individual investor certainly does not mind always being the first to
receive information, but he does not like others to receive the information
first - .especially if it is bad news that negatively affects the value of the
security he owns. In that case getting the information first might have made
it possible to avoid a loss. The situation is different, however, if the investor
does not own the security affected by the information. It is then only a matter
of missing the opportunity to purchase on good news or sell short on bad
news.
Certain realities suggest that information may not reach each investor at
the same time. For example, some investors can spend all day in a brokerage
firm office accessing the wire service and other news sources. Other inves-
tors might have accounts which are large enough that their brokers constant-
ly monitor the information that affects the securities in which they are
interested. Most investors, however, must rely on the evening news or the
next day's paper for the same information. The literature is replete with
studies which suggest that by the time information appears in the media
available to the majority of investors, that information has already been
captured in the price of the securities (e.g., 2, 3, 4). Any real world imperfec-
tions that keep investors from getting the same information at the same time
add to the uncertainty perceived by investors. Similarly, if people perceive
themselves to be at an informational disadvantage, their uncertainty in-
creases even if they are not at an actual disadvantage. The increased uncer-
tainty results in a lower price for the firm's shares, since other things equal,
the more uncertain a benefit, the less the value.

Interpretation
A second source of information uncertainty involves the interpretation of
available information. For various reasons investors may not properly evalu-
ate and utilize information useful in forming/revising expectations. If, for
example, the firm historically has issued erroneous "information", investors
may hesitate to have confidence in that firm's current and future information
offerings. Lack of credibility increases uncertainty and, correspondingly,
decreases share price.
In addition, the form that available information is in can increase the
chance of investor misinterpretation. And, any confusion that accompanies
this misinterpretition can diverge investors' opinions. A lack of market
consensus in itself can increase uncertainty as perceived by investors. It will
also probably increase variability in the firm's stock price; when divergence
of opinion is great, price might momentarily reflect over or under reaction by
investors to the information.
6
 In summary, although many factors undoubtedly affect investors' per-
ceived uncertainty, we focus on how investors perceive information accessi-
bility. Remember that perceptions, not necessarily reality, affect investor
behavior. Second, we are interested in uncertainty caused by potential
misinterpretation of information. Generally, managers can control firm-
related information, and they can take measures to reduce uncertainty from
this information.

III. DECISION RULE

Given the expected package of benefits associated with a firm's stock -
dividends and appreciation in share value - reducing investors' perceived
uncertainty will increase share value, assuming investors prefer less uncer-
tainty to more uncertainty, other things being equal. Thus, even if manage-
ment has already made decisions and taken actions that affect the package of
expected benefits, any steps that reduce uncertainty will increase share
value. This leads to the decision rule.

RULE: DO THOSE THINGS THAT DECREASE INFORMATION

UNCERTAINTY AS PERCEIVED BY INVESTORS.

Management can take specific steps to promote equal access to informa-

tion and to reduce investors' perceived uncertainty about information.
These actions should increase share value. So as not to confuse the effects of
other variables, assume management has made the investment and financ-
ing decision. The following actions should increase investors' confidence in
information accessibility and interpretation.
Management should 1) develop a policy regarding the release of informa-
tion about the firm, 2) consistently follow this policy and 3) make known to
investors the information-release policy they have adopted. The policy
should limit the opportunity for certain individuals to trade on released
information, i.e., the information should be made available to all investors
simultaneously. The firm should insure (and assure investors) that "bad"
news will be as readily forthcoming as I'good" news. Disclosure practices
should aim to minimize the chances that investors may misinterpret the
information. The policy should also contain certain provisions that reduce
investors uncertainty about availability and accessibility of information.
Specifically, the following guidelines are appropriate:

- Management should release all information after the market (on which
their firm's stock trades) is closed. Thus, more investors can get the
information before any trading opportunities.
- As soon as management knows information of potential interest to
investors, they should release it. If one suspects the information has or
will definitely "leak out", ignore the first guideline and dispatch the
7
 information as widely and quickly as possible. State why you did not
wait until after the market closed.
- Management should demonstrate a willingness to provide investors
with favorable as well as unfavorable information.
- The information should be clearly presented; management must mini-
mize the chance that investors will form misinterpretations.
- Management should welcome the questions of analysts and reporters
but have a specific policy to follow in dealing with such queries. Answer
telephone questions only after markets have closed. In case of personal
visits, ensure that analysts will not release any information until after
the markets close. The firm itself should release a summary of any
information provided to analysts.
- The firm should establish a track record of providing as much informa-
tion to investors as possible. Such openness by management instills
confidence that all news will be shared with investors.
- Management should not hedge when presenting information. If man-
agement does not fully understand the implications of a certain de-
velopment, they should clearly state and assess the possibilities and
admit uncertainty concerning the outcome .
- Projections should be realistic. When management realizes the projec-
tions are not as reliable as originally thought, the projections should be
revised. Investors must sense that management will keep them
appraised of all developments.
- Management should develop an approach to handle rumors about the
firm. Generally it is best to have a policy of either always or never
responding to such rumors. The merits and shortcomings of the Ilal_
ways or never" approach need to be assessed prior to establishing the
policy.

IV. SUMMARY
In addition to other factors, uncertainty perceived by investors affects
how investors value a firm's shares. Aside from numerous actions which
management may take (e.g., with respect to investments, financing, growth
in earnings per share, and dividends) managers can reduce the uncertainty
perceived by investors regarding two factors: (1) equal access to information
and (2) misinterpretation of information. Reducing uncertainty froln these
sources will increase share value. Managers should implement the specific
steps suggested to minimize uncertainty from these sources.

REFERENCES

1. K. CareYJ "Nonrandom Price Changes in Association with Trading in Large

Blocks: Evidence of Market Efficiency in Behavior of Investor Returns," Journal of
Business, October, 1977/ pp. 407-414.
8
2. J. Jaffe, "Special Information and Insider Trading," Journal of Business, July, 1974,
pp. 410-428.
3. J. Groth, "Security-Relative Information Market Efficiency: Some Empirical Evi-
dence," Journal of Finance and Quantitative Analysis, September, 1979
4. J. Groth, W. Lewellan, G. Schlarbaum, and R. Lease, "Security Analysts: Some
Are More Equal," The Journal of Portfolio Management, Spring 1978, pp. 41-48.
5. J. McCain and J. Millar, A Note on Public Information and Stock Prices," Journal
JJ

of Business Research, January, 1975, pp. 61-64.

6. J. Staffels, JJStock Recommendations by Investment Advisory Services: Immedi-
ate Effects on Market Pricing, "Finanacial Analysts Journal, March 1966, pp. 44-86.

9
 GUIDE FOR THE DEVLEOPMENT
OF A STRATEGIC PLAN INTRODUCTION

James M. Tipton

Department of Economics, Finance & Insurance

Hankamer School of Business
Baylor University, Waco, Texas

INTRODUCTION
Bank and thrift organizations are beginning to devote a considerable
amount of time and effort each year to the process of establishing goals and
objectives and developing profit and operational plans for the ensuing year
(2). This type of planning is generally characterized as operational or tactical
planning since it is concerned largely with building on and improving the
status quo. It is generally the responsibility of the Asset/ Liability Committee
(ALCO) to administer and monitor the tactical plans within a financial
institution. A major component of the ALCO's responsibility is the manage-
ment of interest rate risk.
Another dimension of planning is that which is termed as strategic plan-
ning. Strategic planning is the process of planning for change in the orga-
nization. It typically involves an on-going program of an objective assess-
ment of the organization's current position; its strengths and weaknesses;
the opportunities and threats presented by external forces such as the
actions of competitors, political and regulatory changes, social and
technological changes, etc.; and finally, the development of plans or
strategies and the commitment of resources to implement these strategies in
order to bring about significant and positive changes in the organization.
The objective is to capitalize on strengths and opportunities, to overcome
weaknesses, and to anticipate the effect of changes brought about by exter-
nal forces rather than being overwhelmed by these forces. One of the major
benefits derived from strategic planning is the abilit)7 that it affords mana-
gers to make better decisions in their day-to-day operations by virtue of
having thought out what it is they are attempting to accomplish in the longer
term.
The purpose of this paper is to present a guide which is being used by
banks and thrifts in the development of their strategic planning. The
approach of the paper, though broad in nature, allows detailed implementa-
tion procedures as well as analysis and forecasting on the microcomputer.!
Financial institutions can be viewed as an aggregation of a diversified
number of separate and distinct businesses offering many different products
10
and services to different customer groups. The approach to strategic plan-
ning is to first develop functional Strategic Plans for each organizational
product or unique area of service. The overall Strategic Plan is then de-
veloped through the process of approving or modifying these individual
Strategic Plans in order to channel the organization's resources into those
areas which offer the greatest potential for achievement of the institution's
goals, i.e., profit, quality, service, growth, etc.
Each functional area of the organization should prepare a Strategic Plan
centered around its products and services. The resulting Strategic Plans
should be viewed as long-range plans for the organization's major areas of
business (service) and not merely the plan for an individual division or
group (3). In most instances, each of the various lines of business (services)
involves the interaction and cooperation of a number of different functional
areas or groups. The final plan for a given line of business (service) should
reflect input from all of the areas involved in providing that service. As a
follow-on process, individual divisions and departments may then develop
their own Strategic Plan to support the overall line of business or service. In
some instances, support areas, i.e., data processing, personnel, etc., will not
be able to complete their strategic plans until after the plans for the major
lines of buisness (service) have been completed and approved.
Strategic planning, as opposed to opportunistic decision making, is an
on-going process and should be thought of as a cycle, a cycle that occurs in
an organization on an annual basis. The results of the first year strategic
planning cycle should produce both a one-year plan and a five-year plan. On
subsequent years the strategic planning cycle should prod1lce the long range
plan with a one-year update. The initial cycle will be the most time consum-
ing and the most difficult to accomplish because of the learning and manage-
ment discipline required.

STRATEGIC PLANNING CYCLE

The Strategic Planning Cycle for a particular line of business or functional
activity should consist of at least the following eight planning elements:
I. Mission Statement
II. Internal Analysis
III. External Analysis
IV. Goals and Objectives
V. Strategies For Action
VI. Management Review Action
VII. Implementation
VIII. Evaluation
The development of the strategic plan for a particular line of business of
service should be coordinated with, and have the benefit of, the input from
all departments/groups involved in providing the service involved. Care
should be exercised to select the most talented people for key planning
11
 Figure 1
STRATEGIC PLANNING CYCLE

_ ~~_____ _ ANNUAL UPDATE -

<,~~:7J-----

1
EVALUATION
r -1 OF PEOPLE

~
r
I
r--I-N-T-E-l:i\jAL~
J

I PERFORMANCE
N i FINANCl1\L 1!
I\ A~ALYSI~.~J I
r-----
I ESTABLISH GOALS I ESTABLISH 1/ Five
PROGRfu'1
MISSION/ - IN"'E- 1". Nf,,\T"\ ' J;\ND OBJECTIVES - STRATEGIES / Year Strategic
SCOPE
>,,1 ( QUALITATIVE) !jv.:.
. J.. l\., ,!.J \

1. Qualitative FEEDBACK
1. Resource Requirc::ment8 Plan
~
I AND

-r--& I
STATEMENT \-ANALYSIU 2. Quantitative 2. Reward/Return \ ACTION and
MONITORING
3. Alternatives 3. Risk "~1PLE}fENTATIO
EXTERN!J.I
\ Q.UALITL\TlVE
I \....~NAL'tSIS_ EVALUATION
l ,--_/ OF PRODUCT
PERFORMANCE

<:~_ ANNUAL UPDATE

... <';::1r-----
positions, no matter where they are in the organization hierarchy. It is
important to keep planning as separate as possible from the organizational
structure.
The proposed goals, objectives and strategies are reviewed in detail by a
planning group or a strategic planning committee. It may modify goals as a
result of capital constraints on the organization, the need to give priority of
resources to other areas of the organization or for numerous other reasons.
Once the various functional Strategic Plans have been approved, appropri-
ate individuals will assume responsibility and accountability for the attain-
ment of the goals and objectives established. Figure 1 is a flow diagram of the
Strategic Planning Cycle.

I. MISSION STATEMENT - This is a carefully thought out, concise state-

ment of the central purpose of the organization as it currently exists. The
mission statement should clarify the nature of the organization's business
describing its scope and long-range intent. It should provide the focal point
around which all the organizational effort revolves and supports. Like the
total organization's mission statement each division or department of the
total organization should also have a mission statement briefly describing
that organizational unit's purpose, scope and intent.

II. INTERNAL ANALYSIS - A logical point of departure in any attempt to

plan where we go in the future is to review our progress over the past three
to five years and take an objective look at how well we have performed. We
need to analyze our strengths, weaknesses, products/services, customer
base, staff, anticipated constraints and the costs involved. A committee will
be established and assigned the responsibilities of researching the following
aspects of each product:
1. Past Performance. Depict the trends of your product(s) over the past
five years in terms of dollars, volumes of activity, profitability, growth or
other significant measures. Comment on any significant factors that have
impacted the year-to-year trends.
2. Strengths/Weaknesses. As objectively as possible, list the strong points
and the weak points of your organizational unit. What do you think is the
image of your unit internally and in the eyes of its customers?
3. Staffing. Present an analysis of your current staff in terms of age of key
personnel, experience and expertise in their field and the degree of stability
or turnover experienced in the staff.
4. Product/Services. Describe briefly each of the major products or ser-
vices your organizational unit offers. Discuss the year-to-year growth in
each of these products or services and its relative profitability.
5. Customer Base/Potential. Present an analysis of your present customer
base considering such matters as the number of customers served, the
degree of concentration and diversity of the customer base, geographic
13
dispersion of customers, etc. If a significant portion of your unit's profitabil-
ity is dependent on a few key customers, give an objective evaluation of your
position with each of these customers, i.e., relationship with key indi-
viduals, factors which could cause you to lose that customer, etc.
6. Constraints. What factors within our organizational unit keep you from
doing a more effective job? This could be current organization policies and
the quality of performance by other organizational units upon whom you
depend. Also consider the way your unit is organized in terms of work
assignments and the adequacy of physical facilities.
7. Cost to Produce the Products/Services. Determine to the degree possi-
ble the cost to produce your product or services. How much per unit? Is it
profitable and by how much?
III. EXTERNAL ANALYSIS - In addition to looking in the organization
and assessing past performance, it is also essential to look outside at various
external factors that influence productivity. To supplement your commit-
tee's efforts it may be necessary to seek assistance from the Strategic Plan-
ning Committee which will be able to offer guidance and suggestions on fact
finding and analysis. Principle areas of research should include:
1. Competition. List banks, S&Ls, and other firms that you consider to be
the major competition in your market area. Analyze to the degree possible
their strengths and weaknesses and your best guess of the share of the
market they currently hold.
2. Market. Describe in terms of geographic area and total dollar volume
the current and potential market for your unit's services. Estimate the share
of this potential market you currently serve. Indicate portions of this poten-
tial market that appear promising for further cultivation.
3. Environment. Any "attempt to develop plans for the future of any
business must take into consideration external forces and the environment
in which you will be required to operate. A close examination of past trends
and current developments can give you considerable insight into what you
may be faced with in the future.
The major external forces which will impact the bank and all financial
institutions in the future can be grouped under the general headings of:
• Political/RegUlatory
• Social
• Technological
• Economical
The major probable developments in each of these areas need to be
researched and applied each time the organization completes the Strategic
Planning Cycle.

IV. GOALS AND OBJECTIVES - Up to this point we have reviewed past

performance, assessed current operations with emphasis on strengths,
weaknesses and postition in the competitive marketplace, and attempted to
14
anticipate the factors in the environment which may impact our business in
the future.
As a result, you should have a reasonably clear perspective on how
effectively you are presently conducting the principal activities, how pro-
ductively the resources are currently employed, what your capacities are,
how external factors will influence future performance, and where, in gen-
eral terms, the organization is headed. This all comes down to the primary
managerial challenge of the long-range plal1ning process - what do we
want the organization to be and where should the organization be heading,
and then what must you as a manager do, and when, if you are to attain the
desired results.
The first step in this process is the development of goals and objectives for
the organization. Goals are defined as the ideal end or outcome of purpose-
ful action. They are the important conditions and outcomes that you wish to
attain, and toward which you direct your efforts. These can include such
matters as improving profitability, increasing share of market, provding the
best in services, challenging the human resource, accepting community and
industry responsibilities, etc.
Objectives represent the translation of goals into measurable terms. They
are primarily quantitative performance targets designed to strive for the
achievement of a goal. Objectives are accompanied by specific assignments
of responsibility and achievement dates. Objectives should be both realistic
and challenging. Objectives are supported by statements describing meas-
ures of effectiveness.
Measures are a means of determining whether or not an objective (and
eventually, a goal) is being achieved. A measure indicates the progress made
at any point in time toward reaching an objective; i.e., the degree to which a
tangible impact on a specific situation is being realized. Measures also help
you determine the rate at which resources are being expended in reaching
objectives and whether or not you are operating within your planned
budget. There are measures of efficiency and measures of effectiveness.
1. A Measure of Efficiency reflects an ability to perform certain tasks with
skillful use of resources or to accomplish desired results with little wasted
resources. Measures of efficiency indicate how economically resources are
being utilized. They are usually expressed as cost per work unit produced,
cost per customer, cost per employee hour, units produced per hour, or as
some other expressed relationship between production and resources.
Measures of efficiency do not usually provide an indication of the quality of
output. Example:
• Employee Compensation (salary) as a % of revenue.
• Percent reduction of operating costs over the past six months.
2. A Measure of Effectiveness reflects the value or quality of the product
or service provided. Not in itself concerned with how efficiently resources
are being utilized, an effectiveness measure provides an indication of how
successfully resources are being applied to the objectives. Effectiveness
15
measures tend to be more subjective than efficiency measures since value
judgments are involved, but should be quantifiable when possible. Ex-
ample:
• % of market gain over the past year.
• % increase in ROA during 19_ _.

v. STRATEGIES FOR ACTION - Strategies are defined as the specific

action plans, programs and projects selected from among alternatives by
means of which an organization intends to attain its goals and objectives.
They are the commitment to specific action aimed at capitalizing on
strengths, correcting weaknesses, solving problems, grasping opportunities
and improving performance. This is the who, what, where, and how phase
of the planning process in which goals are translated into action plans and
individual responsibilities through formal planning decisions and com-
munication sessions.
In reaching the decision point of the strategy, it is important that the range
of feasible alternative courses of action available to reach a given objectjve be
evaluated. The strategy (action plan) selected through this process of evalua-
tion will be the one which is expected to produce optimum results in the
most efficient manner, consistent with corporate goals and objectives, with-
out affecting undesirable trade-offs or levels of risk, such as short-term
profits verus long-term asset quality. Not only does this evaluation of
alternative strategies expose all facets of a decision to analysis, it also leads to
the development of contingency plans which are useful in the event condi-
tions change and strategies need to be altered.
Among the factors to be considered in determining what course of action
will be adopted and how it will be carried out are:
1. Corporate performance goals and priorities.
2. Anticipated competitor strategies/responses.
3. The specific levels and types of resources required, together with their
cost and availability.
4. The means of deploying new resources (or redeploying existing re-
sources).
5. The costlbenefit implications.
6. Acceptable trade-offs in terms of profit,risk and customer relations.
7. The impact upon market or internal relationships.
8. The probablility of success.
9. The assignment of responsibility for the completion of specific tasks by
required dates.
In describing each strategy adopted, these supporting elements should be
spelled out clearly. A brief summary should be prepared to state the case for
each proposed strategy (e.g., new program or project, new product, change
in pricing, different approach to existing markets, new market thrust). It
should set out clearly the contribution (performance impact) the strategy
will make toward attainment of the related objective(s), the resources re-
16
quired, the estimated incremental costs and incremental benefits of such
programs, projects, markets and products, and the alternatives which were
considered and why they were rejected. Be certain to describe not only what
you plan to accomplish, but how specifically you plan to do it. The following
general questions are provided as guidelines:
1. Basic Profitability and Performance:
• How will you monitor product (service) profitability? By what
criteria?
• How specifically do you plan to increase income? Fees? Service
charges?
• Are there new opportunities to increase income? Where? How?
• How do you monitor the profitability of a customer relationship? At
what point do you drop a relationship?
• What programs can be initiated to better control and/or reduce staff
expense and other operating costs?
• Which unit expenses are fixed and which are variable? How variable?
How will you manage variable expenses more effectively?
• Are there operating efficiencies that can be realized?
• What programs should be emphasized to capitalize on the strengths
of your unit previously described? Minimize the impact of weakness-
es? How do you plan to correct these weaknesses?
2. Marketing and Competitive Position:
• What particular market segments and customer groups offer the
greatest opportunity for profitable growth?
• Based upon your recognition of the services and products you pro-
vide, and the feasible limits of your ability to cover the market, what
mix of services should we offer to meet the needs of these markets
most profitably?
• How can the profitability of existing markets be increased (improved
margins, reduced expenses, greater penetration/volume, culling,
de-emphasis or abandonment of marginal or unprofitable markets or
products)?
• How do you view the profit potential of new markets and/or new
products/services?
• Are certain markets likely to be vulnerable to competitive rate/price
cutting in the future?
• How can you enhance the quality, service and pricing of your pro-
ducts/services to customers (product management)?
• What types of customers should you concentrate your calling efforts
upon? Which are the most profitable? Least profitable? What are
your priorities?
• What needs to be done to improve business development activities
and calling officer skills? How can you better structure your calling
program?
• How can you cross-sell other banking services more effectively?
17
 • What changes are planned to improve the customer appeal of your
services and products? Your delivery systems?
• How can you improve the effectiveness of your advertising and
promotional programs?
3. Innovation:
• What new products, programs or services do you plan to introduce?
When? How? Results anticipated?
• How can your unit be more responsive to customer needs for new
products or services?
• How can we encourage and implement the development and design
of innovative services, programs and products?
• What research, EDP and/or operations support do you require?
• What is your plan for implementation? Who? How? When?
• What services do you plan to delete or change? When? Impact?
4. Productivity and Efficiency:
• What programs do you plan in order to promote productivity in-
creases, superior competitive performance and profitability? How
will you measure/monitor results?
• How can the organization handle increasing volumes with existing
staff and facilities?
• What programs do you plan to implement in order to improve the
quality, quantity, efficiency and timeliness of your operations?
• Do you have under-utilized capacity (e.g., people, equipment, facili-
ties) in any area? What do you intend to do about it?
• How efficient and effective is the organization structure and division-
al working relationship communicated? Do they support your plan?
What needs to be done?
• What new systems do you require in order to implement your plans?
• What research is required?
5. Financial Resources:
• What price/cost relationships do you require to meet your profit
projections?
• What is your estimate of net funds required (provided) over the
planning period?
6. Human Resource:
• What are the personnel needs required to fulfill your profit objec-
tives? To implement your programs? What categories and when?
• What changes, if any, do you require in recruitment, training or
evaluation of performance, and how do you expect to achieve this?
• How can you develop managerial/supervisory personnel more effec-
tively?
• What administrative, operational or structural changes are necessary
to meet your profit goals?

18
 7. Capital Expenditures:
• What new facilities and/or equipment will you require to attain your
profit objectives and over what time frame?
• How will this be accomplished, and what are the costlbenefits?
• What are the trade-offs?
• What space requirements do you foresee over the next three to five
years? Cost? Benefits?
8. Social Responsibility:
• How do you intend to contribute to achievement of the organiza-
tion's Equal Employment Opportunity Compliance and Affirmative
Action program? What is your specific program?
• What things can you do to promote the growth and development of
your market area?
• What programs can be developed to respond more effectively to the
consumer movement? What profit potential can be developed in
doing so?
It is important that planning efforts be coordinated and integrated among
all line and/or staff units which will be involved in the implementation of a
plan. A review program is intended to assess the advantages and risks of
each plan, assure coordination between units of the organization in the
development of related elements of their plans, evaluate the trade-offs, and
provide consistency between corporate and unit goals and objectives
throughout the organization.
Contingency Planning: It is important to consider what impact such
variables as price, competition, economic conditions, technological change,
and the like, could have upon performance. In developing strategies and
programs, these critical variables should be identified, responsibility should
be assigned for monitoring them, and an effective means (contingency plan)
for dealing with each should be formulated. At minimum, consider the
impact of economic/monetary oscillations, and build sufficient flexibility
into the plans that will allow for their change or modification.

VI. MANAGEMENT REVIEW ACTION - The management review action

is the process of presenting, reviewing and deciding upon the Strategic
Plans. Each staff department or divisional manager will present his Strategic
Plan to Executive Management for a review. The written plan is to be
submitted to Executive Management at least one week prior to an oral
presentation. Each Strategic Plan is to be presented in a standard format
which includes the following elements:
1. Mission Statement
2. Products/Services
3. Internal Analysis
• Past Performance
• Strengths
 Figure 2
STRATEGIC PERSPECTIVE
Il·1PLEMENTATION

DEPT/DIV SUPPORT
ORGA~IZATIO~ UNITS
(Develops 1 & 5 Yr.
Strategic Plans)
• . i i-------r- I I
Mort~~age

SE~\OR
Lending
Non-Hortgage Lending, ~XEClJ\\DN
. i
Trus t i Servic.(~s ,
Marketing &'Cus~oQer Service~ ; : 0 I O~ . ONr: I\ND FIVE
Operations/Data ~rocessing ,I . I
{\\~~i\(;Et'\el\)T
Accounting & ;Control, i
0 ' ; I I i
'{Ef\~ STRf\TEGlC
N
Employee' Relatiorts : 1 .: t~YOLVEI'l\~\1
! !
PL(\~
1
o Investment Servi~es 0

; !
Funds Hanagement '
I ,

----;>...
STI.<ATEGIC
rLANNING
CO~·~1ITTEE
"~
7
EXECUTIVE
REVIEW ~I ~ MISSION
~I
P-(ofi t Business/Project Strategic

()
 • Weaknesses
4. External Analysis
• Competition
• Market Potential
• Threats
5. Recommended Goals and Objectives
• One Year
• Three to Five Years
6. Strategies for Action/Resources Required/Follow-Up Plan
7. Recommendations for Decision
Figure 2, Strategic Perspective, clarifies the functions and responsibilities of
each portion of the strategic planning process.

VII. IMPLEMENTATION - The responsibility for implementation of a

management decision rests with the managers accountable for affected
functional areas. If the plan is approved, the resources required to imple-
ment the plan should be identified and their expenditure approved. It will be
the responsibility of individual managers and their employees to implement
their plans on a day-to-day basis in order to achieve their objectives within
the resources approved. Throughout this day-to-day management/imple-
mentation process, records must be kept and observations made to evaluate
the effectiveness of the Strategic Plan.

VIII. EVALUATION - The evaluation process should take place on a

continuous basis throughout the implementation phase of the cycle. A
formal evaluation is to be made each year on how well the organization has
performed against its plan and established objectives. The evaluation pro-
cess is divided into two formal assessment activities:
1. Evaluation of People Performance. This is carried out by each boss/
subordinate during their annual performance planning and performance
review discussions. Employee Relations Department assists management in
this area by providing performance evaluation forms and coordinating the
activity.
2. Evaluation of Product Performance. This activity is monitored by each
manager against his department's goals and objectives. Emphasis is given to
sales performance, market share, and profits.

SUMMARY
Strategic planning and strategic thinking have become necessities for
increasing profits in that they provide a means to deal with change. Changes
in economic conditions, regulatory requirements, legal structure, growth
and diversification, and increased competition must be projected and dealt
with effectively. Without prior planning and preparation there is little
chance one will utilize change to any extent.
21
 Upon completion of the Strategic Planning Cycle, management will have a
basis for:
• Making better decisions regarding
- Budgets
- Space
- People
• Improved communication to all employees through the context of the
job.
• Motivating employees through responsibility and achievement.
• Rewarding employees through performance.
• Achieving the organization's goals and objectives.
A word of warning is in order. Strategic planning is a highly creative
process. To be successful, planning requires imaginative thought rather
than mechanistic procedure. Without flexibility in the planning process
there is little chance that the organization will be able to adapt to unantici-
pated external and internal conditions. Finally, without regularity there is
little chance that planning will be anything more than a "quick-fix."

NOTES
lComputer programming is available from the American Bankers' Association for
use on the microcomputer which allows low cost strategic information. The primary
manual, Microcomputer Modeling to Improve Community Bank Financial Performance,
brings both modeling and analytical powers to users for approximately forty dollars
($40.00). In addition, the basic model is easily adaptable for thrifts as well as asset/
liability (tactical) modeling.

REFERENCES
1. Ernest, J.W., and Patera, G.E., "PlanIling and Control systems for Commercial
Banks," The Changing World of Banking, Prochnow, H.V., and Prochnow, H.V.,
Jr., Eds., New York: Harper and Row, 1974, pp. 244-277.
2. Gluck, F., Kaufman, S., and Walleck, A.S.,"The Four Phases of Strategic Man-
agement," The Journal of Business Strategy, Vol. 2. No.3, Winter 1982, pp. 9-21.
3. Cup, B.E., and Whitehead, D.O., "Shifting the Game Plan: Strategic Planning in
Financial Institutions," Economic Review, Federal Reserve Bank of Atlanta, Decem-
ber 1983, pp. 22-33.
4. Johnson, H.E., "Comprehensive Corporate Planning for Banks," The Bankers
Handbook, Baughn, W.H., and Walker, C.E., Eds., 1978, pp. 273-287.
5. Jones, CeL, "Know Thy Niche," The Bankers Magazine, July-August 1982, pp.
32-35.
6. Kahn, S.J., "Management Strategies for the '80s," The Southern Banker, June 1982.
7. Metzger, R.O., and Rau, S.E., "Strategic Planning for Future Bank Growth," The
Bankers Magazine, July-August 1982, pp. 57-65.
8. Microcomputer Modeling to Improve Community Bank Financial Performance,
Washington, D.C.: American Bankers Association, 1982.
9. Nelson, R.R., "Strategic Marketing," The Bankers Magazine, July-August 1982, pp.
43-46.
22
10. Porter, M.E., Competitive Strategy: Techniques for Analyzing Industries and Competi-
tors, New York: The Free Press, 1980.
11. Rockwell, G.B., "Strategy Development," The Bank Director's Handbook, 1981, pp.
153-170.
12. Thompson, T.W., Berry, L.L., and Davidson, P.H., Banking Tornorrow, 1978,
chapters 2, 3, 4, 11.
13. Yalif, A. , "Strategic Planning Techniques." The Magazine of Bank Administration,
April 1982, pp. 22-26.

23
 CHAPTER 11: A TOOL OF STRATEGIC MANAGEMENT

Arthur D. Sharplin
Department of Management
Northeast Louisiana University
Monroe, Louisiana

Since the current bankruptcy law was enacted in 1978, there has been a
virtual avalanche of bankruptcy filings. The number of "straight" bankrupt-
cies, under Chapter 7 of the U.S. Bankruptcy Code, more than doubled from
1979 to 1983; but the number of "reorganizations" under Chapter 11 almost
quintupled, to more than 18,000 filings in the year ending July 31, 1983. Just
as remarkable as the number of filings is the diversity of strategic purposes
which have been served by those filings (1).
Because of the uses to which Chapter 11 has been put, many feel that the
law should be repealed or its provisions modified (2). Repeal appeared to
have been effectively accomplished in 1982 when the Supreme Court ruled
Chapter 11 to be unconstitutional because of the extraordinary powers it
confers upon bankruptcy judges, who lack the lifetime tenure and the salary
maintenance protection which insulate other federal judges against political
influence. However, the law continues in effect under a "Special Rule,"
which was established by the federal judiciary in December 1982. Under the
Special Rule, bankruptcy judges operate with district court oversight and
controversial matters are heard by district court judges if a party at interest in
the bankruptcy court so moves.
The Supreme Court has refused to hear challenges to the Special Rule and
several appeals courts have upheld its constitutionality. In addition, pro-
posed bills in Congress would cure Chapter 11's unconstitutionality by
essentially incorporating the provisions of the Special Rule (3). In light of
this, it appears probable that the provisions of Chapter 11 will remain in
effect for a long time and corporate managers will continue to take advan-
tage of its provisions to serve themselves or one or more of their multiple
constituencies. Let us consider how Chapter 11 can be turned to the benefit
of different constituent groups, especially the managers themselves.

Managers May Extend Their Tenures or Obtain Favorable Severance

Most executives who file Chapter 11 petitions for their companies do so to
their own benefit, if not for their own benefit. By the time a company seeks
protection under the bankruptcy law it is usually doomed to failure without
such protection and company executives are facing imminent loss of their
24
jobs. After a Chapter 11 filing managers typically continue in office and
enjoy full pay, benefits and perquisites. They may even be able to enhance
their compensation packages. Of course, a party at interest in the bankrupt-
cy court may object to the executive pay and benefits, but this seldom occurs.
In a small percentage of Chapter 11 cases, professiQnal "turn-around
artists" are employed. Among the better known of such specialists are
Sanford Sigoloff, the new leader of Wicke's Corporation; Joe B. Freeman, of
AM International; and Victor Palmieri, the chairman of Baldwin United
Corporation. When these specialists take over, they typically replace senior
managers and often fire managers far down in the organizations. Even then,
however, top managers frequently leave on very favorable financial terms.
The deposed chief executive of AM International, for example, received
severance pay along with a lucrative consulting contract. When the senior
vice-president of Manville Corporation left shortly before the Chapter 11
filing, he did so under a new and highly favorable early retirement plan. The
two top executives of International Harvester, which threatened a Chapter
11 filing for more than a year, left with millions in severance pay and debt
forgiveness. Such results are predictable because executive compensation
typically accounts for a small proportion of total corporate expenses and
there are much more pressing matters facing creditors and other parties at
interest. In addition, any top management team which is deposed without
gracious treatment can contest their removal in the cognizant district court.

Power and Cash Simplify the Management Job

Company management has increased power under Chapter 11 because it
is typically able to pick the forum in which the Chapter 11 process will be
conducted. There are districts which tend to be "pro-debtor" and others
where creditors are favored. In the Western District of Louisiana, for exam-
ple, top managers are often replaced with a trustee. In the Southern District
of New York, where Cincinnati's Baldwin United and Denver's Manville
Corporation filed, this does not happen. The bankruptcy code allows a
bankruptcy petition to be filed wherever the company has had a "principal
place of business" for the 180 days preceding the Chapter 11 filing. For most
major corporations, this includes almost any bankruptcy district in the
United States. Even smaller companies can establish a "principal place of
business" in any district where they desire to file as long as they anticipate
the filing, even potentially, as much as six months in advance. This allows
management to "judge shop" and to select that district in which they feel
that they are most likely to have their way.
Managers who stay in power after a Chapter 11 filing may find their jobs
much easier to perform. The monthly struggle to pay maturing debt ceases
and cash shortages are usually quickly eliminated. Receivables due at the
time of the filing flow in and payables, leases, trade accounts, installment
notes, etc. no longer have to be paid. This can produce from thousands to
25
hundreds of millions of dollars in added cash. (Post filing cash and near cash
exceeded $65 million at Continental Airlines and $200 million at Manville.)
Until a reorganization plan is confirmed - and to some extent thereafter-
prefiling creditors have little control over what is done with inflowing cash.
Management is relieved of the trying responsibility of dealing with dozens
or hundreds of separate creditors and can confront them collectively
through their duly appointed committees in the bankruptcy court. When
Continental Airline's secured creditors tried to restrict the use of cash from
prefiling accounts receivable, they were unsuccessful. Of Manville's more
than $230 million in cash and marketable securities as of June 30, 1983, only
$77 million was restricted as to use.
Managers of most companies feel obligated to provide creditors with
timely financial information whenever they demand it. Under Chapter 11,
however, such timeliness is not required. While bankruptcy law contem-
plates monthly financial reports, many courts allow substitution of Secur-
ities and Exhange Commission Forms 10-K and 10-Q. The 10-Q forms are
filed within 45 days after the end of each calendar quarter and the 10-K
reports are required three months after year end. So corporate managers
typically have additional power because they have access to and control over
financial facts and figures which creditors and others do not have - at least
for a few months.
Top managers of a firm which has filed a Chapter 11 petition typically have
the power to dismiss employees and other managers willy-nilly or to afford
exceptional benefits to those whose allegiance they consider most useful.
"Saving the company" justifies almost any kind of extreme action. The
necessity to compensate valuable team players to get them to give their best
to a company which may not have a long term future provides a rationale for
high pay. There is really no need for company management to struggle with
the question of whether a manager is really worth the amount paid or not
because any savings achieved through compensation efficiencies typically
must be allocated to provide additional payment to creditors and other
claimants.
Managers operating under the shield of Chapter 11 may also have an
easier time meeting competition in the marketplace. Not only have they
avoided some of the usual expenses of doing business, like interest and
some of the principal on unsecured debt, there is no real need to sell at above
the cost of production if pricing below costs will make the sale. Besides, any
profit made will usually just go to pay creditor claims.

Eliminating Problem Divisions

Chapter 11 also simplifies the management job by providing a rationale for
disposing of difficult to manage and/or unprofitable segments of the com-
pany. The typical pattern in major company reorganizations is to sell off
whole divisions, thereby obtaining cash while improving profitability and
26
simplifying management. Manville sold its Belgium operation - by the
way, to the managers of that organization - and its U.S. pipe operation
along with a large number of other assets and divisions. Wickes Corporation
sold its House of Fabrics chain, a furniture manufacturing division, and a
number of other units. If management sells any part of the company at all,
this makes the job of managing easier. But it is possible to concentrate upon
disposing of those elements that require most of management's time and
energy while retaining decentralized and profitable parts of the company.
The debtor in possession is required to report major asset disposals to the
bankruptcy court and sometimes the proceeds from such sales are restricted
as to use, but it is seldom that such sales are effectively opposed.

An Easy Assignment: Minimize Profits

Prior to the confirmation of a plan for reorganization, managers actually
have an incentive to minimize profits, a condition which greatly simplifies
the job of management. Executives need not worry that low profits may cost
them their Chapter 11 shield. The provisions of the bankruptcy code which
allow the conversion of a Chapter 11 proceeding to a Chapter 7 liquidation
are seldom used. Even if such an effort is made by creditors it can be
contested in the district court by management. Any attempt to vacate a
Chapter 11 petition can be similarly resisted. In one Chapter 11 case in
Shreveport, Louisiana the bankruptcy judge ruled that he debtor should be
stripped of Chapter 11 protection. The Company appealed that ruling to the
district court and immediately filed a new Chapter 11 petition, which the
bankruptcy court honored. A similar motion has been filed by the Asbestos
Claimants Committee in the Manville Case. That motion was not carried
forward for more than a year. Such efforts in other cases are likely to meet
with little success because of the heavy burden the bankruptcy code places
on a party which desires to have a Chapter 11 case converted to a Chapter 7
case and because of the presumption that the "debtor in possession" that is,
current management, will continue to operate the firm while in Chapter 11.
If prior to filing a reorganization plan, the bankrupt firm were to earn
significant profits, this would surely result in creditor demands for a larger
percentage payout to themselves and stockholder resistance to any effort to
dilute their interest or diminish their returns under a reorganization plan.
So, in the period between the filing of a Chapter 11 petition and the con-
firmation of a reorganization plan there are strong incentives for minimizing
profitability as long as this can be done without risking conversion to a
Chapter 7 liquidation, imposition of a liquidating plan under Chapter 11, or
the replacement of company management by other managers or a trustee.
Even after a plan is confirmed there is often little reason for company
management to put forth the effort required to earn profit. Amounts due
unsecured creditors are often stated as a percentage of profits and more
profits just means that more must be paid. Second, management can prob-
27
ably defer payment of planned amounts with relative impunity, standing
ready to appeal any adverse bankruptcy court decisions to the district court.
A successful Chapter 11 might be defined as one in which the debtor in
possession (1) files a reorganization plan providing for payment of all or a
portion of the company's debts over an extended period of time, (2) pays
those debts in accordance with the plan, and (3) emerges from reorganiza-
tion a profitable company. Of the 200 or more cases which have been filed
since 1978 in the Western District of Louisiana, not a single case meets this
definition. This relfects the disincentives which managers have to fulfill the
spirit of Chapter 11.

Extending the Grace Period

If managers desire to delay the confirmation of a reorganization plan
under Chapter II, it is usually easy to do so. For the first 120 days after a
Chapter 11 petition is filed, management alone has the right to propose a
plan of reorganization. This 120 day period can only be extended or allowed
to expire. If it expires, any party at interest, including a stockholder, a
creditor, the bankruptcy court, or perhaps others, can propose a plan. If this
were to occur in a major case, pandemonium might result, with many plans
being filed and probably with no plan likely to receive the required commit-
tee approvals for confirmation. Because of this spectre, bankruptcy judges
are hesitant to terminate the 120 day exclusionary period and the period is
often extended for a year or more. Even if management believes that the
current extension at a particular time is "the final one" it is only necessary to
propose a reorganization plan, however unlikely that plan is to be con-
firmed. As long as the plan is submitted "in good faith," the debtor in
possession is automatically granted another 60 days to win approval of the
plan by various committees. This period, too, can be extended for as long as
the judge feels that there is some likelihood of achieving a confirmable plan.

Potential Benefits to Stockholders

It is possible for a Chapter 11 proceeding to result in a great improvement
in shareholder interest, either collectively or as separate groups. It is even
possible that Chapter 11 might benefit particular shareholders at the ex-
pense ·of others of the same class.

Stockholders in General
To begin with, Chapter 11 can hardly damage shareholder interest for a
company which is truly insolvent. When companies are liquidated under
Chapter 7 unsecured creditors seldom get significant payment on their
claims. Rare indeed would be any return at all to shareholders, preferred or
common. Just as rare would be a Chapter 11 reorganization plan which
eliminates all shareholder equity. Such a plan would hardly receive the
required two-thirds approval of shareholders.
28
 If, as is usual, the Chapter 11 proceedings result in the elimination of some
corporate debt, the payment of such debt over extended terms without
interest, or the substitution of equity for debt, the company's equity secur-
ities have some potential value. In addition, the favorable tax treatment of
debt discharges under bankruptcy law accrues to the benefit of shareholders
(4). This is reflected in the fact that Manville Corporation common stock,
after having sold for less than $8 per share shortly before the Chapter 11
filing, increased to the range of $12 to $16 per share during 1983. In Novem-
ber 1983 Revere Copper's common stock was selling around $13 per share
and Baldwin United's was priced at over $3 a share.
Shareholders may benefit in a major way if management is able to gain
confirmation of a reorganiazation plan which provides for a reasonably
quick payout of a small percentage of corporate debt· and then if manage-
ment tries to maximize company profitability. Of course, the amount and
terms of payment for which creditors will settle is largely dependent upon
their perception of the alternatives. If ,managers convince creditors that
company profitability will be low, creditors are likely to accept either a low
percentage of payment or very extended payment terms.
Until recently, the payment terms under Chapter 11 plans typically ex-
tended for less than five years after confirmation. Recent plans have tended
to provide full payment of claims but over a period of up to ten years. In fact,
a plan suggested by District Judge Edelstein in the Manville Corporation
case contemplates payment over at least a 20 year period and perhaps
longer. Judge Edelstein suggested that the entire profit of the company be
allocated to pay claims. If management were forced to follow a plan which
contemplates such extensive payouts over such a long period of time, it is
unlikely that shareholders in the aggregate would benefit. It is possible
though, that after profits fail to meet expectations and payments are corres-
pondingly low management might be able to negotiate a revised plan less
I

favorable to claimants and more favorable to shareholders. After that, man-

agement might be encouraged to put forth the effort required to increase
profitability.
If a company is solvent when its managers lead it into the Chapter 11
process, the shareholders stand a very good chance of losing, even though
debt may be reduced and certian expenses may be avoided. The perverse
incentives to management discussed above may lead managers to sub-
optimize shareholder interest.
In some cases (Continental Airlines, Braniff, Wilson Packing Company,
among others) Chapter 11 filings allowed the renegotiation or outright
avoidance of labor contracts. In others (Rath Packing Company, Food Fair,
Inc., among others) pension costs were reduced by' termination of retire-
ment plans, renegotiation of contribution rates, or withdrawal from mul-
tiemployer plans (5) Any contract, executory or not, may be avoided or
renegotiated under the threat of cancellation by the debtor corporation. This
29
includes leases, supply contracts, debt indentures, and many more which
may involve continuing costs for the obligor. Shareholders in solvent com-
panies which file under Chapter 11 may benefit when any of these contract
modifications or cancellations decrease costs.

Preferred vs. Common

If a single committee represents preferred and common shareholders, as
is typically the case, common shareholders should usually gain in relation to
the preferred shareholders because of a Chapter 11 reorganization. In case of
liquidation, preferred shareholders would receive the par value of their
shares before anything went to common shareholders. Since the bankruptcy
code requires a two-thirds vote in amount of each class of interests before a
reorganization plan can be confirmed, the common shareholders will nor-
mally block confirmation of any plan which fails to provide them significant
benefits. preferred shareholders, on the other hand, usually benefit vis a vis
creditors because these shareholders would normally receive nothing in a
Chapter 7 liquidation and are able to insist upon some benefits to gain their
acceptance of a plan.

Individual Shareholders
Even though stockholders in general may not gain from a Chapter 11
reorganization, it is possible that certain individual shareholders will. This is
especially true for those holding large blocks of stock or those who have
reliable sources of information about how the Chapter 11 is going. As the
fortunes of the company ebb and flow with each new filing by a party at
interest and with each new ruling by the cognizant bankruptcy judge or
district judge or by other judges in related cases, stockholders who are able
to predict the impact on share prices are able to buy and sell profitably. In the
Manville Corporation case, both common and preferred stock prices have
gyrated widely as various developments have occurred in the case. For
example, Manville common shares which sold for less than $5 the day after
the Chapter 11 filing sold for a high of $16 in 1983 with several variations in
the 30 percent range during the intervening months. Revere Copper's com-
mon stock ranged from 43/4 to 14 'l's in the year after that company's filing. In
general these variations did not follow changes in the productivity or earn-
ing capabilities of the corporations but rather accompanied the various
pleadings and rulings in the cases. The opportunity that these kinds of
variations provide for persons with special contacts need not be explained.

How Creditors Fare

The bankruptcy code appears to provide adequate safeguards to protect
creditors from losing from a Chapter 11 reorganization as compared to a
Chapter 7 liquidation. The code requires that the reorganization plan pro-
vide a settlement for all claimants at least as favorable as that they would
30
receive under a Chapter 7 liquidation. It would also at first appear that
creditors can make sure they gain from Chapter 11 by withholding their
approval of any proposed reorganization plan which provides less than
what they would receive under Chapter 7. However, any real losses which
occur after the Chapter 11 filing may reduce the amounts which creditors
eventually receive. Because of the flexibilities allowed under accounting
convention, managers have little trouble hiding moderate real losses. In
addition, no matter how much has been lost up to any point in the Chapter
11 process, creditors are likely to find it difficult to terminate the process as
long as management is able to show a prospect for improvement. So,
reorganization often proceeds along until creditors are much worse off than
they might have been at the start with a liquidation. For example, Samba's
Restaurant, Inc. lost more than $30 million after filing for Chapter II,
provoking the assistant trustee in the case to conclude that there would be
nothing at all left for the unsecured creditors and not enough to even pay the
claims of secured creditors.
Even when the company's assets are not depleted through losses, unse-
cured creditors may lose because they are often not paid interest on their
claims. In fact, it is not even necessary to accrue such interest in the debtor's
books. Secured creditors may lose because the value of the assets on which
they hold liens may be diminished through use and lack of maintenance. At
the same time, as in the Sambo's case, the company's other assets may be
depleted to the extent that nothing is available to make up the deficiency in
the liened property. Continental Airline's secured creditors tried to protect
themselves against this eventuality by asking the bankruptcy court to re-
strict certain cash balances. The judged refused to do so. Of course, secured
creditors have access to their collateral to the extent that it is not required for
the continuation of the business, but managers seldom have any problem
showing that a partiuclar asset is required. Consequently, secured creditors,
at a minimum, often must accept delay in payment (6).
Creditors of all kinds may come out ahead, as compared to how they
would fare upon liquidation. This would be the case if current corporate
managers, notwithstanding the disincentives to do so, have both the ability
and inclination to operate the company more profitably than potential
purchasers. Of course, this should rarely be true.

Conclusion
Chapter 11 provides a procedure which may produce major and con-
tinuing benefits to corporate managers and almost certainly improves the
situation for stockholders, but which is exceedingly unlikely to benefit
creditors. Company managers are the primary referees as well as the main
beneficiaries.

31
 REFERENCES
1. For an interesting overview of some of these purposes, see Anna Cifelli,
"Management by Bankruptcy," Fortune (31 October 1983), pp. 69-72.
2. James E. Stacy, "Innovation Through Bankruptcy?" Business Horizons (Marchi
April 1983, pp. 41-45. While Stacy reports the clamor for tightening the bankruptcy
law, he feels that such sentiment is misguided, that the law as it stands benefits the
public by encouraging innovation.
3. For a readable discussion of the "Special Rule," see David Ranii, "Bankruptcy's
Twilight Zone," The National Law Journal, Vol. 6 (7 November 1983), pp. I, 9-11.
4. Richard A. Noffke, "Discharge of Indebtedness Under the Bankruptcy Tax Act
of 1980," Taxes, Vol. 60 (September 1982), pp. 635-649.
5. Richard S. Soble, "Bankruptcy claims of Multiemployer Pension Plans," Labor
Law Journal (January 1982), pp. 57-63. Soble discusses the difficulties of collecting
pension liabilities from bankrupt companies which withdraw from mulitemployer
plans.
6. See, for example, "Continental's Feisty Chairman Defends Deregulation - and
Himself," Business Week (7 November 1983), pp. 111-115.

32
 DEFINING YOUR BUSINESS MISSION:
A STRATEGIC PERSPECTIVE

William A. Staples and Ken U. Black

School of Business and Public Administration
University of Houston - Clear Lake

Introduction
One of the major problems for managers of business organizations is to
allocate the necessary time for planning the future direction of their com-
panies. Most of one's day is spent on administrative or tactical problems to
the exclusion of issues of a more strategic nature. This occurs more frequent-
ly in smaller companies in which a manager may have to handle both the
day-to-day operations and the long-range planning. However, even in large
organizations, strategic or top level managers often spend a high percentage
of their time devoted to internal rather then external matters.
The purpose of this article is to discuss the nature of strategic planning for
the manager of either small or large organizations. While the time allotted
and depth of analysis for strategic planning may vary by size of company,
the basic procedure remains the same. In addition to providing an overview
of the process of strategic planning, specific emphasis will be given to the
importance of defining your business in terms of a company's mission
statement. The argument will be made that once an organization has defined
its business mission, the remaining steps of the strategic planning process
will become easier for the manger.

Strategic Planning Process

The process of strategic planning involves a number of steps that involve
analyses of conditions both inside and outside the organization. Table 1 lists
the major steps in the strategic planning process. (1) The initial step is the
definition of the company's mission and management philosophy. The
statement of mission and operating philosophy will basically define the
types of business ventures, both product and market, which a company will
pursue. A second step in the process would be to assess the company's
internal strengths and weaknesses. An analysis of most companies would
reveal one or more dominant functions, such as marketing, production,
finance, or research and development. At the same time a company is
identifying its strengths, the weaknesses tend to be revealed as well. The
third major step shifts to outside the organization in terms of monitoring
changes in the external environment. Key elements of the external environ-
33
ment that are included for analysis are competitors, customers, suppliers,
and dealers or distributors. In addition, attention should also be devoted to
changes in cultural or social attitudes, technological advances, the state of
the economy, the political climate, and legal requirements.

TABLE I
STRATEGIC PLANNING PROCESS
1. Define the company's mission and management philosophy
2. Identify internal strengths and weaknesses
3. Monitor changes in the external environment
4. Identify opportunities and threats
5. Formulate specific goals or objectives
6. Identify and evaluate alternative strategies
7. Select a strategy or strategies
8. Prepare functional plans to support each strategy

At the completion of the first three steps, the management of a company

should be able to identify some actual or potential opportunities or threats.
A given change in the external environment will normally have a positive,
negative, or no effect on a company. With respect to managerial decision-
making, the task is to capitalize on the opportunities and minimize the
threats. One author (2) has suggested that an environmental opportunity
mayor may not be a company opportunity. The following assumptions may
be in order to determine if an environmental opportunity is worth pursuing
from the company's point-of-view. First, every environmental opportunity
has specific success requirements. Second, each company has distinctive
competencies or things it can do especially well. Third, a company is likely to
enjoy a differential advantage in an area uf ~nvironmentalopportunity if its
distinctive competencies or strengths exceed those of its actual or potential
competitors.
Once opportunities or threats have been identified, some specific pro-
grams may be required. Whether a program is designed for an opportunity
or a threat, some goals or objectives will be necessary. With respect to
opportunities, most objectives traditionally refer to measures such as sales,
market share, profits, or return-on-investment among others. The problem
is that managers often fail to state specific objectives. While "increasing
market share" may be a worthy objective, "increasing our market share for
brand A by 5% by the end of 1984" is more meaningful. With the latter
objective, a person in the company would know the extent of the increase
desired in market share as well as the time period in which to accomplish the
objective. For control purposes, the second objective will be much easier for
34
program and personnel evaluation. Managers should also remember to set
objectives when they are trying to minimize a possible threat. For example,
"Decreasing customer complaints by 15% during the next calendar year"
would also be an appropriate objective.
Once the overall goals or objectives have been formulated, a manager
must identify and evaluate alternative strategies which may be used to attain
the objectives. From a company-wide perspective, six major possibilities are
available for consideration. The six options are presented in Table 2. The
strategy option with the least risk will be market penetration which would
involve attempting to gain greater sales, market share, or profits by being
more productive in our existing markets with our existing products. If
management decided to enter new markets with existing products, market
development would hopefully occur. On the other hand, if either minor or
major changes were made in the product offering, product development
would be the strategy. The most risky approach would involve a change in
both the product offered and market served which would result in a diversi-
fication strat~gy. A company may also desire to explore the possibility of
gaining greater control of the manufacturing or distribution of its product
through forward or backward integration. For example, a retailer may assess
the feasibility of backward integration with respect to obtaining an interest
in a wholesaler or manufacturer. Horizontal integration could also be
selected and would involve the purchase of a competitor. A final strategic
option is to cease offering a given product or serving a particular market due
to a variety of factors, including increased competition, declining sales and
profits, or the existence of alternative products and markets which offer a
greater potential gain.

TABLE 2
STRATEGY ALTERNATIVES

1. Market Penetration 4. Diversification

Existing Products New Products
Existing Markets New Markets
2. Market Devleopment 5. Integration
Existing Products Vertical
New Markets Horizontal
3. Product Development 6. Market or Product Contraction
New Products
Existing Markets

The actual selection of a strategy will depend to a large degree on the

company's strengths and its current product-market situation. It is not
35
unusual for a company to pursue multiple strategies at anyone time. for
example, while a company may always strive to do a better job with its
existing products and customers, the company may also be entering new
markets or introducing new or improved products or services. Due to
increasingly short product life cycles, the strategy of product or market
contraction will also occur more frequently than desired for most com-
panies. Regardless of the strategy or strategies under consideration for
selection, a manager may wish to consider three questions. (6) The first
question, "Where are we now?", involves an assessment along traditional
lines of sales and profitability although other indicators may also be used.
The second question, "Where do we want to be?", should point to desired
levels of some of the same indicators used to answer the first question. The
third question, "How shall we get there?", forces the manager to consider
using one or more strategic options to attain the desired position.
The final step of the strategic planning process requires the preparation of
functional action plans to support each strategy that will be implemented.
This step means the beginning of the transition from strategic to tactical
planning. While the individual functional plans in research and develop-
ment, production, and marketing may be relatively easy to prepare, the
integration of these functional plans into an overall tactical plan may be very
difficult. The tendency exists for each department within the organization to
stress their dominant concerns. For example, production usually stresses
long production runs of few models, while marketing desires the opposite.
The need for functional integration is particularly critical when a company
embarks on major changes in their products, markets, or both.
While each of the eight steps of the Strategic Planning Process listed in
Table 1 could be the focus of an article, the reminder of the discussion will
focus on the initial step of defining a company's mission and management
philosophy. The next section discusses the qualifications of an effective
mission statement.

Company Mission Statements

The preparation of a company's mission statement is one of the most
critical and fundamental components of the strategic planning process. As
noted in Table 1, the definition of the company's mission and management
philosophy is the initial step in strategic planning. However, this critical step
is often the most difficult activity for management to undertake and com-
plete. A number of leading authorities in management have suggested the
level of overall importance of a mission statement. One authority (4) sug-
gests that the mission statement stake out broad areas of business in which
the firm can, or perhaps cannot, operate. Another expert (7) advances the
idea that the mission statement is the foundation on which detailed objec-
tives, strategies, and tactical plans can be worked out.
36
 Given the importance of a company's mission statement, the major con-
cern of managers is how to approach this activity. One author (2) has
suggested that a mission statement is developed by answering questions
such as "What is our business? Who is the customer? What is value to the
customer? What will our business be? What should our business be?"
Answers to these questions may be an appropriate step in the formulation of
a mission statement. However, one individual (5) has indicated that the
mission of a company should fit the following qualifications:
1. It should define what the organization is and what the organization
aspires to be.
2. It should be limited enough to exclude some ventures and broad
enough to allow for creative growth.
3. It should distinguish a given organization from all others.
4. It should serve as a framework for evaluating both current and
prospective activities.
5. It should be stated in terms sufficiently clear to be widely understood
throughout the organization.
An example of a company's mission statement may help to clarify the
relationship of the mission statement to the strategic planning process. It has
been suggested (8) that Southwest Airlines' primary mission or purpose is
"to provide mass transit for as many passengers as possible". In accordance
with this mission statement, Southwest Airlines has stressed lower fares to
increase the overall market as well as its own market share. Specific actions
taken include minimum fares, frequent flights, and high labor productivity.
Compare the above mission statement for Southwest Airlines to the follow-
ing for a publishing firm which states its mission is "to provide high quality
textbooks" or a drilling equipment manufacturer's mission "to provide
quality drilling equipment to the oil industry". The major limitation of the
last two mission statements is a reliance on a product, rather than a custom-
er, orientation. The difference between a product or customer orientation is
a key to establishing a management philosophy to guide the present and
future activities of the organization.

Management Philosophy
The content of a company's mission statement will vary to a large degree
on whether a company defines its business in product or customer terms.
One author (3) has suggested that firms succeed or fail over time based on
their ability to define themselves in terms of customer needs. The tendency
for managers to define their businesses too narrowly in product terms has
been called "marketing myopia". Table 3 provides some examples of the
differences between a product and a customer-defined business.
The critical point for managers to consider with respect to formulating
their company's mission statement and management philosophy is that
37
basic customer needs continue long after a given product or service has
vanished from the marketplace. While the need for a telephone may some
day be non-existent, the need for communication will continue. Similarly,
while the need for oil and gas may diminish, the need for energy will exist.
The identification of potential opportunities and threats in the strategic
planning process will hinge to a large extent on how managers view changes
in the external environment. The adoption of a customer-orientation for
defining the company's mission should help to spot both opportunities and
threats which may have been missed or simply dismissed if a company was
operating under a product-dominated management philosophy.
While some managers may believe that a product definition is objective
while a consumer-orientation is subjective, they should recognize that the
majority of successful products and service are geared to specific customer
needs. Rather than developing a product and trying to find a market, the
operating philosophy of organizations should be to identify customers
needs and then provide a product or service to fulfill those needs.

TABLE 3
PRODUCT VERSUS CUSTOMER ORIENTATIONS

Product-Orientation Company Customer-Orientation

Telephones AT&T Communication
Oil and Gas Exxon Energy
Railroads Union Pacific Transportation
Movies Universal Studios Entertainment
Bowling Balls Brunswick Recreation
Computers IBM Information Processing
Banking Chase Manhattan Financial Services

Conclusions
The purpose of defining your business mission is to specify the purpose of
the company and to provide direction for those who work in the organiza-
tion. The argument has been advanced (5) that the organization which has a
clear understanding of why it exists, what it wants to achieve, and for
whom, is more likely to succeed. In addition, the emphasis on strategic
management and planning is likely to increase in the future; so the activities
of the strategic planning process will become critical for long-run survival. A
statement of a company's mission and management philosophy should
enable a manager to successfully undertake the task of identifying and
implementing effective business strategies.
38
 REFERENCES
1. Henry, Harold W., "Strategic Management: Longer View, Broader Options,"
Survey of Business (Spring, 1981), pp. 4-9.
2. Kotler, Philip, "Strategic Planning and the Marketing Process," Business (May-
June, 1980), pp. 2-9.
3. Levitt, Theodore, "Marketing Myopia," Harvard Business Review (July-August,
1960), pp. 24-47.
4. Linnemann, Robert E., Shirt-Sleeve Approach to Long Range Planning for the Smaller
Growing Corporation, (New York: Prentice-Hall, 1980).
5. McGinnis, Vern J., "The Mission Statement: A Key Step in Strategic Planning,"
Business (November-December, 1981), pp. 39-43.
6. O'Dell, William F., Andrew C. Ruppel, Robert H. Trent, and William J. Kehoe,
Marketing Decision making, (Cincinnati, Ohio: South-Western Publishing Com-
pany, 1984).
7. Steiner, George A., Strategic Planning - What Every Manager Must Know, (River-
side, New Jersey: The Free Press, 1979).
8. "Upstairs in the Sky: Here Comes a New Kind of Airline," Business Week (June 15,
1981), pp. 78-92.
 A Comparison of Strategies for Expensing
Business Property

Wallace Davidson and Sharon Garrison

Department of Finance, Insurance, Real Estate & Law
North Texas State University
Denton, Texas

The United States Tax Code provides taxpayers with ma11Y options or
tradeoffs of which people in business should be aware. Whenever a tradeoff
is granted, the taxpayer needs to be able to determine which of the options is
optimal given his/her current economic status.
The Economic Recovery Tax Act of 1981 (ERTA) includes a provision that
provided taxpayers with a choice. Under ERIA, a taxpayer may write off
property, up to certain limits, as an immediate tax deduction or may elect to
receive an investment tax credit and depreciation deduction. Under the first
alternative 100% of the cost may be expensed during the tax year of acquisi-
tion. Under the second alternative, the total tax writeoff is greater than
100%, but it occurs over a longer period of time. This problem is a classic case
in which the taxpayer must choose between a larger amount or, a faster
writeoff.
This paper presents a concise, clearly stated solution to this problem. By
understanding the results in Table I, a taxpayer with business property will
be able to make the correct tax decision.

I. The Economic Recovery Tax Act

The Economic Recovery Tax Act of 1981 (ERTA) includes a provision that
was designed to be of particular benefit to small businesses or individuals
with business property. This provision gives the taxpayer the choice of
treating certain investment property as an expense in lieu of capitalizing and
depreciating such property. Section 179 outlines the election to expense
certain depreciable business assets. Section 179 property is defined as prop-
erty that would ordinarily be covered under the ACRS depreciation codes
and which is acquired by purchase for use in a business or trade. Such
property is allowed as a deduction on the taxpayer's return for the year in
which the property is placed in service. The aggregate amount which may be
deducted for any taxable year may not exceed the following amounts:
1982 $ 5,000
1983 5,000
1984 7,500
1985 7,500
1986 and thereafter $10,000
40
 In the case of a husband and wife filing separate returns, the applicable
amount on each return shall be 50% of the above amounts. If a taxpayer
elects to expense business property, then those amounts may not be depre-
ciated under the ACRS statutes. If such property is not used in the trade of
business at any time before the close of the second taxable year in which the
property is placed in service, then regulations provide for recapturing the
deduction.
Whether to take the first-year writeoff or to take an investment tax credit
(ITC) and depreciate the property involves some planning on the part of the
taxpayer. Strategies depend on the value of the first year tax deduction
versus the aggregate value of the investment tax credit and depreciation of
the asset. The value of each of the alternatives will be examined in the next
section.

II. The Value of the Strategies

Taxpayers have the option to expense an asset with a price of $7500 or less
in 1985, or to take an investment tax credit (IrC) and depreciate the asset.
Since there is a choice involved, it will be shown that the optimal solution
depends upon the taxpayer's tax bracket and opportunity cost of funds. Any
taxpayer will be able to use the valuation models which follow to determine
the optimal strategy. Our analysis will proceed by first examining five year
ACRS property, and then three year property will be discussed separately.
When a depreciable asset is purchased, a taxpayer may, pursuant to
ERTA, expense that asset up to a maximum limit specified earlier. In other
words, the asset may be used as an immediate tax writeoff. With proper tax
planning the taxpayer may reduce his withholdings immediately. There-
fore, the value of this strategy is:

v~ = (cost of the asset) (tax bracket) (1)

V~ = xt

V represents the value of the strategy. The superscript denotes five year
property, and the subscript shows that this is the first of the two alternatives.
The value of the strategy depends upon the cost of the asset, x, and the
taxpayers tax bracket, t. Notice that a taxpayer in a larger tax bracket gets
greater value from expensing the property. In other words, deductions are
more valuable to taxpayers in higher tax brackets.
The second of the two alternatives would involve taking a 10% investment
tax credit and depreciating the asset over its five year life. Since the passage
of the Tax Equity and Fiscal Responsibility Act of 1982, the depreciable base
of the asset must be reduced by one half of the lIe or in the case of five year
property by 5%. We can see that, the value of this strategy is:
41
 4
V~ = .10X + .15 (X - .05X)t + .22(~ ~ .~5X)t + I .21 (X - .05X)t (2)
i=2 (1 +k)i

where: x is the cost of the asset

t is the taxpayers tax bracket.

The first term on the right is the 10% ITC. The second term is the first
year's depreciation tax deduction. A five year ACRS asset may be depreci-
ated at a rate of 15% its first year, 22% its second year, and 21 % in years 3-5.
The depreciable base of the property is (X - .05X). It includes the original
cost of the asset X, less one-half of the lTC, .05X. Since the taxpayer, through
proper tax planning, can reduce the tax liability immediately (by reducing
the withholdings for individuals or reducing the quarterly tax payment for
companies), this second term does not have to be discounted. The third term
is the present value of the second year's depreciation deduction discounted
at the taxpayers opportunity cost of funds, k. The fourth term is the sum of
the present value of the third, fourth, and fifth year's depreciation tax
deductions. Notice that this analysis presumes that the first year's deprecia-
tion deduction will benefit the taxpayer immediately. Through proper tax
planning, the taxpayer can reduce the quarterly tax payments made to the
IRS. So the first year's deduction benefits the company immediately.
We now have the value of the two strategies, but the important point is to
determine under what conditions Vf dominates V~. To learn this, the indif-
ference point, Vf = V~ will be found by subtracting V~ from V~. This is done
in (3) below.

v~ - v~ = Xt - .10X - .15 (X - .05X)t - .22(X - .05X)t -

1+k
i
i =2
.2l(X - .05X)t
(1 + k)i
(3)

Notice in (3) that the cost of the asset, X, is multiplicative throughout the
expression. In other words, X can be factored out. The optimal choice
between the strategies is therefore independent of the cost of the asset as
long as the cost is less than the limits specified in the tax code.

II. ·Optimal Strategy

A taxpayer would .be indifferent between the stragegies for five year
property when V~ - V~ = O. Setting equation (3) equal to zero and dividing
through by X yields (3-a):

42
 o= t - .10 - .15(.95)t - .22(.95)t - 4
I .21(.95}t (3-a)
l+k i=2 (1 + k)l

In (3-a), notice that the only two vairable which affect the value of the
expression are the tax rate, t, and the taxpayers opportunity cost of funds, k.
By substituting different tax rates into the expression, the indifference
discount rate can be found. In Table 1 these discount rates are shown for
several tax brackets. If we look in the 50% tax rate column for five year
property, the indifference discount rate is 8.82%. This implies that a tax-
payer in a 50% tax bracket would be indifferent between expensing and
depreciating the asset when that taxpayer has an opportunity cost of funds
of 8.82%. The other cells may be interpreted in the same way.
At discount rates above 8.82%, the optimal solution would be to take the
immediate tax writeoff. A larger discount rate would reduce the value of the
future depreciation deduction below the immediate writeoff. At discount
rates below 8.82% the future depreciation deductions are larger than the
value of the immediate writeoff, so the taxpayer should select the tax credit.
The 10% tax bracket cell deserves some attention. The value of the im-
mediate writeoff would be equal to the 10% ITC. But the depreciation
deductions that are taken ina ddition to the ITC would mean that the
immediate writeoff would never be optimal.
For three year property, the analysis is similar. The value of the two
strategies can be estalbished. The taxpayer may write off the property
immediately or take a 6% ITC and depreciate 97% of the assets cost over
three years. The depreciation rates to be applied to the property for its three
year tax life are 25%, 38, and 37%, respectively. It can easily be demonstrated
that the choice in this case depends on the same variables as in the five year
case, the tax rate and opportunity cost of funds.
The results for the three year property appear in the second line of Table 1.
The interpretation is the same. For a taxpayer in a 50% tax bracket, a discount
rate above 9.33% would favor the immediate writeoff while a ldower dis-
count rate encourages the depreciation strategy.
At low discount rates the depreciation/ITe strategy is optimal. At higher
discount rates the immediate writeoff is optimal. Notice in Table 1 that as the
tax rate drops, the indifference discount rate rises. Since the ITC is a credit
which reduces the tax liability on a dollar for dollar basis, and is therefore
independent of t, it takes increasingly larger discount rates to make the
immediate writeoff strategy dominate the depreciation strategy at lower tax
rates.

Conclusion
This paper showed that the ERTA gave taxpayers a choice with regards to
depreciation of assets. The financial planner must be aware of this choice
43
and must know how to select the optimal strategy. It was shown:
1. that taxpayers may choose to expense assets costing $7,500 or less
rather than depreciating them:
2. that the optimal strategy is independent of the asset's original cost as
long as the cost is below the $7,500 prescribed in the Tax code;
3. that the optimal strategy depends upon the taxpayer's bracket and
opportunity cost of funds; and
4. that at a given tax bracket, a larger opportunity cost of funds favors the
immediate writeoff strategy.

Table 1
The Indifference Cost of Capital* For
Various Tax Rates

Tax Rates 50% 46% 40% 30% 20% 10%

5 Year Property 8.82 10.05 12.54 20.02 43.42 **
3 Year Property 9.33 10.56 12.98 19.85 37.60 208.06

*At discount rates greater than those shown in the table, the taxpayer should
immediately expense the property. When the taxpayer's opportunity cost of
funds is less than those shown, the optimal strategy is to take the ITC and
depreciate the property.
** At a tax rate as low as 100/0, it would never be optimal to expense the asset,
because a 10% ITe taken immediately would be larger than the value of the
future deduction.

44
 PUBLICATION GUIDELINES
The editors of the Journal of Business Strategies invite submission of
manuscripts to be consider for publication. The articles should be concise,
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makers. The emphasis of these articles is expected to tie on new interpreta-
tions, fresh insights, and clearly stated solutions to problems faced by busi-
ness decision makers. The articles should be of practical value to business
people and business educators. It should not be assumed that readers are
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under study. Directness and clarity of presentation are desired.

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REFERENCES:
An alphabetical, numbered list of references cited in the text should be
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