Downsizing and Value Creation at General Dynamics: A PE‐Like Solution for Industries That Must Shrink

Abstract

Finance theory says that companies in declining industries with excess capacity should transfer capital to other sectors of the economy to preserve value, yet this has proven very difficult for firms in such situations to do. The authors showcase a particularly successful case involving defense contractor General Dynamics and explain why that company was so successful at something very few other companies have achieved.Faced with very poor prospects for the defense industry, GD increased the wealth of its shareholders by more than 500% in the three years from January 1, 1990, when sharp defense spending cuts were confirmed after the end of the Cold War, to January 1993. The downsizing, restructuring, and partial liquidation of General Dynamics was a remarkable economic achievement in three important respects. First, managing effectively in a declining business environment required dramatic changes in traditional corporate policies, particularly compensation policies. Second, GD's operating changes had to be closely coordinated with a series of complicated corporate financial transactions that were unprecedented for GD. Third, senior management had to confront extraordinary public relations, political, and labor union challenges. The successful plan involved providing high‐powered and front‐loaded equity incentives for the (largely new) GD senior management team, asset sales, radically lower capex budgets, sharply higher dividends, and aggressive share repurchases. And although many GD employees lost their jobs (or went to different companies), GD shareholders, including many of those same GD employees, ended up handsomely rewarded.