Financing Asset Sales and Business Cycles

Abstract

This paper analyzes the decision of firms to sell assets to fund investments (financing asset sales). For a sample of U.S. manufacturing firms during the 1971-2010 period, we document new stylized facts about financing asset sales that cannot be explained by traditional motives for selling assets, such as financial distress or financing constraints. Using a structural model of financing, investment, and macroeconomic risk, we show that financing asset sales attenuate the debt overhang problem, because asset sale financed investments imply lower wealth transfers from equity to debt than otherwise identical but equity financed investments. This novel motive to reduce the debt overhang problem can explain how financing asset sales relate to firm characteristics and business cycles. We also confirm with simulated panels of model firms that are structurally similar to their empirical counterpart that they indeed feature the dynamic patterns of financing asset sales we observe in the data for real firms.

Size of Financing Need and the Choice between Asset Sales and Security Issuances

“…First, the patterns suggest that a firm with a high leverage is more likely to sell an asset for financing purposes. This supports the hypothesis that an asset sale helps reduce the bondholder‐shareholder conflict (Arnold et al., ). Second, trends in the incidence of an asset sale to the size of financing need look similar for high and low leverage firms, suggesting indifference in the balance sheet effect for both groups.…”

“…Arnold, Hackbarth, and Puhan () investigate the financing choice between an asset sale and an equity issuance from the perspective of the bondholder‐shareholder conflict. In a firm with large debt obligations, its managers working in the interest of shareholders forgo positive net present value (NPV) projects because debtholders have first claim on the income from new projects.…”

“…Arnold et al. () show that financing through an asset sale helps reduce (underinvestment problem) by reducing the size of assets‐in‐place. Leverage is the ratio of book value of total debt to total assets.…”

Divisional Informativeness Gap and Value Creation from Asset Sales

“…They identify three effects (synergy, camouflage, and correlation effects) that drive a firm's choice of asset sales versus equity offering. Arnold, Hackbarth and Puhan () use a structural model with time‐varying macroeconomic conditions and the consumption‐based asset‐pricing framework to investigate when a firm undertakes an asset sale across business cycles. They show that the financing through asset sales reduces the wealth transfer from equity to bond holders.…”

Selling to Buy: Asset Sales and Method of Payment in M&As

“…In this respect, Hovakimian and Titman (2006) and Borisova and Brown (2013) provide empirical evidence that asset sale proceeds are used to fund capital expenditures and R&D investments, respectively. Arnold, Hackbarth, and Puhan (2015) also show that asset sales are often used as a funding source for corporate investment but find evidence that they are sensitive to business cycles. events, which are not confounded by capital structure effects associated with proceeds being used for retiring corporate debt, or with payout (i.e., dividends or repurchases) policy implications related with distribution of cash to shareholders.…”