Case 1

The Case ofEastman Kodak:

Maximizing Shareholder Wealth
Case Summary: Kodak shareholders, actively represented by the firm's board of direc-
tors, had criticized Kodak management for several years, expressing severe dissatisfaction
with low earnings and stock prices. The board is thought to have pressured CEO Kay Whit-
more into hiring an outsider who had a reputationfor ruthless cost cUlling. Less than three
months later, the newfinancial officer resigned. The stock market reacted predictably, with
the stock price rising significantly on the new CFO's appointment and falling when he
resigned. The case outlines some possible causes of Kodak's financial problems that the
hiring of an outsider was designed to alleviate.
The primary goal of the fIrm is to maximize shareholder wealth. This goal is best met
by maximizing the fInn's stock price. There is a growing movement to change the shareholder
concept to that of the stakeholder, which includes consumers, employees, the community,
and the government, as well as shareholders. But other goals may eonnict with maximizing
shareholder wealth. Failure to maximize shareholder wealth can have serious consequences
for a company, Not only will dissatisfied shareholcjers "vote with their feet"-selling their
shares and further driving down the stock price, but a mismanaged company also risks
financial ruin. A low stock price and undervalued assets can also mean a company is vul-
nerable to takeover by another fInn.
Eastman Kodak Co. illustrates the case of a company whose shareholders were grow-
ing progressively unhappier. Its profIts and return on equity had dropped steadily from a
peak in 1988, and its share price fell along wiUlthe firm's prospects. Kodak needed to do
something drastic both to restore the company to profitability and to restore shareholder
confidence in its management.
WHY PROFITABILITY PROBLEMS?
A number of factors contributed to the company's downward slide, primarily Kodak's
investment decisions. Kodak had diversifIed out of its primary business, photography and
related equipment; in other words, it had acquired businesses in unrelated areas. That diver-
sifIcation was blamed for many of Kodak's profItability problems because billions o[ dol-
C"l'yr1ghl 0 1995 by SQuthWestern Collcj,>e Puhlishing.

2
Case j The Case of Eastman Kodak
lars had been spent on research and development in its new businesses, without the reward
of a blockbusLer product.
In keeping with the stakeholder view of the corporation, Kodak promoted its image as
a good eorporaLe citizen, a policy that can be costly. In a public statement, Kodak offi-
cials said, "We at Kodak consider health, safety and environmentnl issues wI to be part of
our ethic of environmcntnl responsibility.'" The primary responsibility for the cnviron-
ment fell under the auspices of the firm's Corpo!"te Health, Safety, and Environment
(HSE) organization, which had a corporate stnff of more Ulan 400 employees. Groups and
units within Kodak also had HSE committees. The firm made substantial donations to
environmentnl groups; for example, it contributed S2.5 million to the World Wildlife Fund
to develop a program to provide educational materials about the environment to children.
This concern increased Kodak's responsibility to the community, but carried a substantial
price tag.
Another of Kodak's problems appeared to be ilS failure to recognize a fundrunenla! shift
in ilS industry. Photography had been a growth industry; new technology was continually
being developed. The two primary reasons amateur photographers take more pictures is the
birth of new children and new photographic technology. Demographically now there are
fewer births as the baby boom generation's children get older and less photographed. New
developments have recenUy been few and far between, and radical change is far in the
future.
The photography business is now mature and not providing nearly the same profit or
potential profit that it used to. A high growth company may be able to pay less attention to
its cost structure. A slow-growth company will not survive if it docs not pay very close atten-
tion to eoslS. Kodak faced increasingly fierce priec and technological competition in its core
pho.tography business. Increasing price competition meant that Kodak often no longer
was the price' leader and had to match competitors' film and processing price cuts.
The photography, or imaging, division was all importnnt to Kodak. It is estimated
that Kodak has about a 75% market share of film and photographic paper in this country
and about 50% internationally. However, the competition has gained ground. Polaroid
began making conventional as wcll as instant film, Fuji Photo Film gained in market share
when it became the official film sponsor of the 1984 Olympic Games, and Konica, another
film rival, increased its U.S. film distribution.
Kodak acknowledged that it had substantial cost overrun problems. Kodak had under-
gone a number of restructurings, which reduced the size of the corporation. In fact, Kodak
underwent five major restructurings from 1985 to 1992, which cost S2.1 billion in extra-
ordinary charges against earnings and reduced the number of jobs by 12,000.
The company's primary research was in the area of digital cameras. These are filmless
cameras that capture still images on a dise or tape. The images are then played back on tele-
vision, like a videocamera's moving images. In response to this expected trend, Kodak
spent over SI billion on electronic imaging research. Chief Executive Officer Kay Whit-
more since announced that imaging research spending would be cut by $200 million in
1993 and $400 million in 1994.
1 Richard Poduska, Richard Forbes, and Maria Bober, "The Challenge of Sustainable Development: Kodak's
Response," The Columbia Journal of World Business, Fall/Winter 1992, pp. 286--291.

The Case of Easlmafl Kodak 3

Another potential cause of Kodak's slide was its purchase of Sterling Drug in 1988.
First the purchase substantially increased the debt in Kodak's capital structure. Kodak tm-
ditionally had little to no debt in iLS capitalihotion. By 1993 it had $10 billion in dcbt, rep-
resenting 59% dcbt in its capital structure-much higher than the industry average of
21%.
Not only was the debt burden high for Kodak, but Sterling was a disappointment to
Kodak overall. Sterling is the producer of Bayer aspirin. Kodak's purchase was made at the
time when health officials were touting aspirin as a heart attack preventive. The expected
increased demand for aspirin as a result of this finding never occurrod, and instead aspirin
faced strong competition from aspirin substitutes made of ibuprofen.
KODAK TAKES GIANT STEPS TOWARD CHANGE
Kodak announced scveral times that maximizing shareholder wealth was its over-
whelming goal. For example, in 1990, Kay Whitmore was quoted in Barron's as saying,
"Shareholders arc our underserved constituency.... Our employecs have done reasonably well,
our suppliers have been compensated, and our cusLOmers have been given reasonable qual-
ity. But in recent years, our shareholders have been under-rewarded. This will change."2
Instead, his prophecy was followed by several more years of declining earnings, eroding
profit margins, and a falling stock price.
Whitmore announced again in January 1993 that shareholders were paramount to
Kodak. To back up his words, he hired a new chief financial officer, Christopher J. Stef-
fen, from outside Kodak ranks. A few days after Steffen's hiring, Kodak stock i ~ e r e a s e d
17% to about 549 a share, an increase in value of 52 billion. Steffen bad a long time rep-
utation of turning around ailing companies, having performed his "magic" at Chryslcr
Corp. and Honeywell, Inc., before coming to Kodak. The first step Steffen proposed was
a much more careful accounting for costs than there had hcen in the past, a prelude to
extensive cost cutting measures.
His appointment was a much more drastic step for Kodak than was readily apparent.
Kodak had a policy of promoting from within.. Steffen's appointment marked the first
time in 20 years that an outsider had been brought into such a high level position within tlle
company. The move appeared to have been made reluctantly. Whitmore was pressured
by his unhappy board of directors to bring in an outsider. The composition of Kodak's
board had changed over lhe previous ten years from one consisting primarily of insiders lO
a more activist board composed of two-thirds ouLsiders. On top of Steffen's appointment,
Kodak announced it would hire other outsiders for key senior staff positions. A Business
Week article on Steffen's appointment noted tllat: "Whitmore sounds like a man preaching
a new religion: shareholder value. Under fire from activist investors, Whitmore has decided
to run the company to maximize earnings and the stock price-a far cry from Kodak's
traditional growth strategy. If taking care of shareholders means scaling the company
down to match its market, so be il."3
2"111e Picture Brightens-At Eastman Kodak, Things Arc Looking Up at All Divisions," Barron's, June 25, 1990,
p.59.
3 "Getting the Picture-Kodak Finally Heeds the Shareholders," Business Week, February I, 1993,
pp.24-26.

4 Case 1 The Case ofEastman Kodak

Whiunore also made it cl= that his job was on the line. The board cut his 1992 bonus
by 70%-to S140,000. Whitmore said if he was unsuccessful at turning Kodak around,
he would offer to resign.
4
A few months later, a Wall Street Journal article published the
day before Steffen announced his resignation, stated, "Investors are hoping Mr. Steffen can
tum the ship around. He promised as much just two weeks into his new job....While it
pains Mr. Whitmore to make any cuts in his company's payroll, Mr. Steffen is proud--{)ven
boastful-of his role in some bloody corporate restructurings....He said inQicling pain is
a given in any reslructuring."5 Steffens' promises included a plan to reverse Kodak's fail-
ing fortunes by ule end of August. By this time, Kodak's market value had climbed a tOUll
of S3.45 billion since his appointment, reaching a high of $53 a share.
The next day, Steffen announced his resignation after less than three months on the job,
and the stock price fe1l5'/.-a loss in market value of $1.7 billion. The resignation was
thought to be the result of disagreements between Steffen and Whitmore about the degree
and speed of cost cutting at Kodak. Steffen's turnaround plan presumably left with him.
Kodak also closely linked its change of heart lDward shareholders to the salaries of high
executives, who were required to hold subsUlntial amounts of Kodak stock. Under Whit-
more's plan, executives must buy and hold one to four times their annual salary in Kodak
stock over a five y=period. Kodak executives previously had only minor shareholdings.
Whitmore, for example, announced his intention to hold $3.8 million in stock, about four
times his annual salary. This plan, though innovative, had been under consideration since
the mid-1980s, confirming the criticism that Whitmore moved too slowly.

QUESfIONS
1. Why were Kodak's shareholders concerned about lower profits when the U1COry says that
it is cash now, not accounting profits, that matters?
2. U.S. companies have frequently been criticized for focusing on the short term at the
expense of long-term goals, such as research and development. Why did Kodak feel a
need to shift to a short-term outlook? Was this good or bad for the company?
3. Kodak seems to have strayed from the goal of shareholder wealth maximization and
was penalized by its shareholders who sold their stock, thereby lowering its price. Was
Kodak serving the interest of a larger body of smkeholders with its policies-for example,
its extensive environmental program? Was this good or bad for the company?
4 This prophecy was fulfilled. In July 1993, Whitmore was asked to resign, and Kodak's board of directors
announced that at outside executive would replace him. Kodak stock rose 3'/4 points to S58.625 on the announcement.
In November, George Fisher, former Motorola CEO, became the CEO at Eastmoll Kodak.
S Joan E. Rigdon, "Contrasting Images: The New Finllilce Cbief m Kodak ]-10' a Slyle Quite Unlike His Boss's,"
The Wall Street Journal, April 28, 1993, p. AI.
., .

The Case ofEastman Kodak 5

4. Because of agency conflict" shareholders assume that managers will act in their own best
interests and will require some proof that their claims for Ole future will be realized. CEO
Kay Whitmore made several announcements over a period of years that Kodak share-
holders came first. How did he "prove" his intentions? How effective was his proof? What
arc the sources of agency costs at Kodak" Which costs are Kodak's new policies designed
to address?
5. To some extent the agent, not the principal, incurs agency costs. Who is paying the
price for Kodak's agency problems? How docs Whitmore pay for potential conflicts
between management and shareholders?
6. Kodak had a tradition of hiring from within Ole firm. 111is can provide internal monitoring
for the firm. How can a policy of promotion from within increase monitoring
and reduce agency costs?