Inefficient Investment and the Diversification Discount: Evidence from Corporate Asset Purchases

Abstract

We provide evidence that investment efficiency considerations are important in assessing changes in firm value surrounding asset purchases. We account for both the potential endogeneity in purchase decisions and the measurement error in Tobin's q. We find that post-purchase, there are significant declines in both excess value and investment efficiency. This trend occurs primarily among those firms that demonstrate increased diversity following purchases. The change in excess value for diversity-increasing buyers is positively related to the change in investment allocation surrounding the purchase.

Deal structure decision in the global market for divested assets

“…They also find that value-destroying divestitures occur when poorly managed (low q) firms acquire assets from low-q firms. Chen and Chen (2011) find that firms that increase their diversity following an asset purchase experience a significant increase in the diversification discount and deterioration in their investment allocation efficiency. John and Sodjahin (2010) find that firms with more antitakeover provisions are significantly more likely to engage in asset purchases, and that the internal governance mechanisms of insider ownership reduce the likelihood of asset purchases.…”

Long‐Run Stock Performance and Its Determinants for Asset Buyers

“…Maksimovic andPhillips (2001, 2002) show that the comparative advantage of a firm is in its main industry, and plants of the largest segments of diversified firms are particularly efficient. Chen and Chen (2011) note that pronounced declines in excess value and investment efficiency after a purchase occur primarily among firms that increase their business diversity. These findings are consistent with the focus explanations of John and Ofek (1995) and Berger and Ofek (1999) in the context of corporate acquisitions.…”

“…They also find that changes in operating performance are negatively related to the asset buyer's free cash flow. Chen and Chen () find significant declines in both excess value and investment efficiency following asset purchases, primarily among firms that demonstrate increased diversity following purchases.…”

“…M&As usually involve the potential problems of the integration of human resources and systems or institutions, while asset transactions have only some or possibly none of these problems. Asset purchases are more likely to be driven by investment efficiency considerations and do not entail the corporate control issues that generally arise in M&As (see Maksimovic and Phillips, 2001;Warusawitharana, 2008;Chen and Chen, 2011). 3 Bates (2005) studies asset sellers' long-run stock returns and finds that firms retaining proceeds of sales gain significantly positive returns, while firms distributing proceeds to debt or equity obtain insignificant returns.…”

“…Lam and Wei () document that limits‐to‐arbitrage and investment frictions separately magnify the degree of the anomaly driven from mispricing and q ‐theory. Chen and Chen () find that both buyers’ excess value and investment efficiency are lower for 3 years after asset purchases.…”