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Sears Case Study

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by Robert A.G. Monks and Nell Minow



The great advantage of publicly held companies is that they bring together capital and managerial expertise, to the benefit of both groups. An investor need not know anything about making or marketing chairs in order to invest in a chair factory. A gifted producer or seller of chairs need not have capital in order to start a business. When it runs well, both profit, and the capitalist system achieves its goals. Our system of capitalism has been less successful when the company does not run well. As some of America's most visible, powerful, and successful companies began to slide, they demonstrated an all-but fatal weakness in the ability of our system to react in time to prevent disaster. Managers and directors at companies like IBM, General Motors, and Sears took their success--and their customers--for granted. They took their investors for granted, too, until it was almost too late.

The problem is that the strength of the system, the separation of ownership and control, is also its weakness. A shareholder's investment in a chair factory gives him certain rights, including the right to elect the directors and the right to inspect the books. These rights may have some meaning when the company is small enough that the investors number in the hundreds. But in large, complex companies, with investors in the millions, they are likely to exercise a third right, the right to sell. While some economists will argue sale of the stock sends a significant

message to management, I agree with Edward Jay Epstein, who said that "just the exchange of one powerless shareholder for another in a corporation, while it may lessen the market price of shares, will not dislodge management--or even threaten it. On the contrary, if dissident shareholders leave, it may even bring about the further entrenchment of management--especially if management can pass new laws in the interim."1 Just because shareholders desert a sinking ship, that does not mean that management will plug the leaks.


Sears Roebuck was a classic example. For nearly a century, Sears deserved the title "America's favorite place to shop." It was the country's leading retailer, its catalogue a genuine part of American history. In the 1950s, the company founded Allstate Insurance. The company diversified into financial services in the early 1980s, acquiring the Dean Witter brokerage and realtor Coldwell Banker. The aim of the purchases was to create a giant supermarket of both goods and services, so that consumers could buy a house, finance it, insure it, and stock it with furniture -- all under the same roof. Wall Street referred to the diversification as a "stocks and socks" strategy.

The financial services performed superbly -- improving the company's earnings from 1984 to 1990 by 55 percent. But in the most literal terms, nobody was minding the store. The vast chain of over 850 outlets, the flagship division of the Sears Roebuck empire, were failing fast. In the seven years up to 1990 the retail group's earnings declined at an annual rate of 7.7 percent. The decline was reflected in the stock which, between January 1984 and November 1990, offered investors a total average return of as little as 0.1 percent.2 The company didn't even meet its own targets. Through the eighties, management continued to promise a return of equity of 15 percent a year. Not once did Sears achieve this goal. Indeed, in 1990, Sears produced a 6.8 percent ROE. [check]

From 1984-1990 Sears had a total annual return, including dividends, of a mere 0.7 percent. 1990 was a disastrous year for the company with earnings and stock prices at 1983 levels, a return on equity of 6.8 percent, and a loss in the first nine months of $119 million. Sears finally lost its century-long title as America's largest retailer, as Sears customers turned to Wal-Mart, K-Mart, and specialty stores like Circuit City, the Gap, and the Limited. But when I first looked at the company in 1990, the retail division was losing to Wal-Mart and K-Mart. In a survey of business leaders, Sears management was ranked 487 out of 500.3 It was no secret that the company's performance was poor, both in comparison to the market as a whole and in comparison to its peers. But all of that was not enough to get management to change direction. What could the shareholders do? They could sell out, as many of them did, even at a loss, but as noted above that does not force the company to improve. Those whose stake was big enough to merit some attempt at communicating with management tried that, too, but with little success.

Sears's twelve largest investors met with CEO Ed Brennan and retail chief Michael Bozic in August of 1990. Brennen and Bozic gave an upbeat assessment of the corporation's plans. But the investors wanted more than rosey projections. They cited a grim share performance -- value had dropped 15 points since 1989 -- and gave Brennan one year to achieve marked improvement in retail, or to look for another job. Brennan fired Bozic, and promised to make cuts.

But it was too little, too late, and the shareholders were not satisfied. In early December, the California Public Employees Retirement System (CalPERS), holder of 2.2 million shares, voiced its concern about Sears's performance, citing depressed stock and the failure of retailing strategies. CalPERS' message, says CEO Dale Hanson, was simple: "From 1984 on, Sears went to hell in a handbag."4 In an open letter to Brennan, Hanson proposed the creation of a shareholders advisory group. Such a group would give the board non-binding advice on matters such as major restructurings, acquisitions, mergers and executive compensation. Hanson hinted that he favored a major restructuring, thus joining the growing school of thought that argued that Sears's value could only be realized when the successful financial divisions were spun off from the plunging retail division.

After discussions with Sears officers, CalPERS agreed not to press for the shareholder advisory committee at the annual meeting in May of 1991, on condition that Sears executives meet with CalPERS at least twice a year. But performance continued to decline, and investors continued to seethe. Fourth-quarter earnings revealed early February showed a 37 percent decline in earnings,



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