Acquisition of Divested Assets and Shareholders' Wealth

Abstract

The divesting of corporate assets has become quite popular. Previous studies of divestitures have found conflicting impacts upon shareholders' wealth of the buying firm. This study measures the impacts of product-line relatedness between the acquiring firm and the divested unit and financial weakness of the selling firm upon the abnormal returns to the acquiring firm. Although the study finds that the impact of financial strength of the seller is ambiguous, the purchase of related assets produces more wealth than does the purchase of unrelated divested units. Further, firms that purchase related divested units have larger proportions of insider ownership. MANAGERIAL DECISIONS TO DIVEST corporate assets or whole divisions arebecoming increasingly popular. In fact, there has been a forty percent increase in corporate divestitures over the past four years, with 2,000 divisions and subsidiaries divested from parent firms in 1984 and 1985 alone [14]. Recent research on divestitures has concentrated mostly upon selling-firm shareholderwealth effects [1,6,7,8,11,15]. This study analyzes buying-firm wealth effects resulting from the purchases of divested assets.Studies of mergers have found that, on average, shareholders of acquiring firms do not gain. However, the acquisition of divested assets may be wealth enhancing. Usually, the sell-off of some of a firm's existing assets is initiated by the seller, and, typically, only one potential buyer actively negotiates to purchase the divested assets [6]. Thus, the divestiture market may not be perfectly competitive, and economic rents may be earned. Rosenfeld [11] explains that "both the acquiring firm and acquired assets have unique resources that earn positive economic rents when combined with the assets of the other firm."The portion of these economic rents accruing to the acquiring firm's shareholders is hypothesized in this study to depend upon the following factors: (a) the relatedness, or strategic alignment, of the buyer and the divested assets, (b) the level of managerial stock ownership of the acquiring firm, and (c) the financial condition of the selling firm. Corporate combinations are more likely to succeed if between related firms and thus can be managed more efficiently. Financial theory does not support business diversification [9]. Also, empirical evidence of mergers confirms that conglomerating purchases do not enhance shareholder wealth [12]. Acquiring related assets is also consistent with stated managerial motives [5]. Thus, we will test whether the acquisition of related divestitures will enhance shareholders' wealth more than the acquisition of unrelated assets. at Columbia, respectively. This paper was begun when both authors were at the University of Florida. 1262The Journal of Finance Concerning the second hypothesis, a substantial portion of the manager's wealth is represented by human capital generated from his or her employment. The manager may wish to reduce his or her "employment risk" by diversifying the real-asset portfolio of the firm (2]. T...

Long‐Run Stock Performance and Its Determinants for Asset Buyers

“…In terms of BHAR_3F, the mean (median) difference between the two sub‐groups is 15.3% (–3.6%), significant at the 5% level (the difference in medians is insignificant). Therefore, buying related assets can alleviate the inefficiency of asset‐purchase activities, consistent with the focus hypothesis and the findings of Sicherman and Pettway (), John and Ofek () and Berger and Ofek ().…”

“…Asset relatedness is a dummy variable that equals one when the four‐digit SIC code of the seller is identical to that of the buyer, and zero otherwise. Other authors find that firms acquiring assets in related businesses earn significantly positive abnormal returns at the announcement of asset purchase (Sicherman and Pettway, ; ). Different definitions of free cash flow are used.…”

“…Some of these benefits are more apparent when one examines related rather than unrelated asset acquisitions. Sicherman and Pettway () find that purchases of related assets produce more wealth than purchases of unrelated divested units. Amit and Livnat () find positive benefits from diversification when related business segments have differential responses to the business cycle to minimize their operating risk.…”

Australian Divestiture Activity: An Examination of Gains to Sell-Off Announcements

“…5 This literature proposes two explanations of the gains observed by financially distressed firms. As financially distressed firms have more limited access to capital markets, the divestiture provides a 'cheap source of funding' to be used in the pursuit of other projects and, therefore, results in abnormal gains (Lang, Poulsen & Stulz 1995;Sicherman & Pettway 1987). The second reason is that, if the poor performance of the firm is driven by an under-performing unit, the subsequent disposal of this unit should result in a positive share price reaction (Cho & Cohen 1997;Denning 1988).…”

Division Management Buyouts of Unrelated Divisions Without a Sales Price Reported

“…SIC codes for the divisions and units are reported by Mergers and Acquisitions ; SIC codes for the parent firms are obtained from the CRSP files. Since the SIC codes provide only a broad measure of relatedness, the sale of a division by a parent with a different SIC code should ensure that the operations of the division and parent differ substantially (Sicherman and Pettway (1987)). …”