Positive Wealth Effects of Divestiture - Literature review Example

? Do Divestiture have Positive Wealth Effects? Literature Review (College Do Divestiture have Positive Wealth Effects? Literature Review Introduction In economics, divestiture or divestment represents partial or full disposal of an investment or asset by way of sale, closure, exchange, or bankruptcy. Divestiture can be practiced fastly or slowly according to its nature of conduct. From the point of view of a business concern, divestiture symbolizes the act of removal of assets from the companies’ books of accounts. This process may include several acts such as sale of ownership shares, closure of subsidiary entities, and bankruptcy of divisions. Therefore, it can be said that a concept of divestiture is the opposite of an investment. The concept of divestiture is very much different from the concept of personal finance. Under the concept of personal finance, the investors sell out their business shares so as to meet their personal objectives. The major scope of a divestiture is that it allows the concentration of business resources in the market, and this process makes the business more profitable. This literature review tends to evaluate the positive wealth effects of divestitures. Motives behind divestitures Evidently, divestiture processes have been gradually increasing since 1990s. According to Kiymaz (2006), the gradually increasing divestiture can be clearly attributed to widespread corporate restructuring activities. The Author points out that the volume of divestitures has increased since 2,057 in 1993 to 3,134 in 1998. Kiymaz also argues that divestitures are the outcomes of a firm’s interest to create and preserve its shareholder wealth and it does not always symbolize the failure of a firm. A divestiture effectively refreshes a business organization and it assists the firm to enter the next phase of growth. The ultimate objective of every business firm is its further expansion and thereby increased profitability. A running business may have thorough knowledge regarding its key areas of strengths and weaknesses. Hence, an organization normally intends to restructure its strategies and concepts in order to address its weaker business areas and thereby focus more on potential growth sectors. In the opinion of Kiymaz (2006), spin offs and sell offs are the two effective techniques for a successful divestiture. Under the spin off methods, a company distributes all the common stocks to its existing shareholders with intent to create a separate publicly traded company. The author asserts that the divested asset is sold to another firm according to the concept of sell off. A spin off does not release its assets out of the company boundaries; instead, it retains within the hands of its shareholders. In contrast, a sell off constitutes complete remolding of the organizational structure and it includes an absolute disposal of some of its assets. However, retirement of succession planning is one of the major elements that influence a firm to adopt the techniques of divestitures. Rationalizing the number of shareholders is another motive behind divestiture strategies. Obviously, every shareholder of a firm would not be able to raise additional funds in times of contingencies. Moreover, every firm likes to retain potential shareholders because only they can contribute to the expansion of the company. The concept of divestiture enables the company to explore its potential shareholders. Colak and Whited (n.d.) claim that conglomerate invest efficiency play a vital role in determining the degree of growth of conglomerates. The authors add that a divestiture can effectively add to the improvement of conglomerate investment efficiency. Therefore, dismantling conglomerates becomes a strong motive behind a divestiture. Similarly, a firm may have earned number of business entities by the way of acquisitions. It is often seen that the acquisition strategies adopted by firms become incorrect and thereby such firms are compelled to discard their acquisitions. Under such circumstances, divestiture is a best method to discard unwanted business areas from dealings. Periodical changes in government regulations may force the business to restructure its organizational strategies and other public policies. In this situation, an effective divestiture can reform the firm according to the changed government requirements. Elements of a divestiture In order evaluate the various wealth effects of a divestiture, it is necessary to deal with the different elements or phases of a divestiture. In the opinion of Hoskisson, Johnson, and Moesel (1994), while taking a decision regarding business divestiture, the management must be concerned with key business objectives and other business priorities. The authors precisely say that a divestiture process should not hurt the basic goals of a business firm. This first phase of planning assists the organization to determine which kind of divestiture strategy is to be adopted. In addition, it is essential to assess the values of the company as well as its market position so as to formulate an effective divestiture policy. Evidently, a thoughtless divestiture program may adversely affect a firm’s sustainability. Hoskisson, Johnson, and Moesel (1994), opine that a firm must prepare its organizational elements viable to change through the practice of a due diligence process. This process aids the organization to immediately catch the outcomes resulted from the divestiture program. According to Harrigan (1981), if a thin resale market exists for the assets of a business unit, an effective divestiture would be very difficult under such a situation. The writer adds that the deterrent effect of exist barriers is found to be another impediment to a successful divestiture. However, these difficulties can be overcome if the firm passes through proper divestiture planning and implementation phases. Every firm analyses the market opportunities and private equity buyers globally with intent to take maximum advantages of divestiture program. In the next phase, the organization develops a competitive strategy so as to rebuild the business best way for the potential buyers. Subsequently, the firm creates favorable situations for a bidding environment on the belief that it would assist the firm to maximize the sales price. According to Hoskisson, Johnson, and Moesel (1994), the final phase of divestiture includes detailed negotiations with concerned parties regarding the pre and post transaction issues. It is obvious that an effective project management plays a crucial role in contributing to a divestiture success. Positive wealth effects of divestitures As discussed earlier, there has been considerable increase in number of divestiture during the 20th century. Kiymaz (2006) reports that the transaction values during the same period have also risen from $76 billion to over $300 billion. This increase in divestiture volumes and transactional values clearly indicate the positive wealth effects of divestiture. The study conducted by Dittmar and Shivdasani (2003) gives evidences of positive wealth effects of divestiture. From their research, they found that divestiture causes a reduction in diversification discount. The authors argue that increased segment investment efficiency is also evident after an effective divestiture. Therefore, the authors conclude that the increased segment efficiency is directly resulted from divestiture and thereby decrease in diversification discount. Efficiency in investment is the basic requirement of any business it adds to the successful expansion of organizations. Increased segmental investment is crucial for any organization to enter the next phase of growth. Dittmar and Shivdasani (2003) claim that there are some interconnections between the concepts of inefficient investment and diversification discount; and the former is responsible for latter to some extent. Authors continue that asset sales (divestiture) improve the investment efficiency for remaining segments. While a business firm divests its non-core assets, it would enable the company management to concentrate more on the core business of the company rather than its unprofitable sectors. This increased focus on potential business areas through divestment would assist the company to take maximum economic benefits. In the absence of a divestiture process, the company is forced to take care of the core as well as non-core business sectors of the organization. Under such situation, the firm needs to deal more time with unprofitable business sectors of the company so as to divert these weaker areas into profitable ones. This condition would inevitably minimize firm’s focus on potential business areas. According to Kiymaz (2006), a divestiture announcement increases the shareholder wealth although there may have variances in the magnitude of wealth gains. In the opinion of the author, both the sell off decision influencing factors such as firm and industrial specific elements cause wealth gain variations from industry to industry. He adds that announcement of sell off activities produces positive effects on “stock returns of both divesting and acquiring firms around the announcement date”. We know that shareholder is considered to be the growth engine of any organization. In other words, they are the owners of a firm since they have contributed to the accumulated capital. Hence, shareholders are also responsible to share the business outcomes whether it is a surplus or deficit. Every shareholder’s ultimate objective is wealth maximization; and a divestiture activity would effectively add to this goal. Since a well designed divestiture process successfully adds to shareholder wealth, this strategy greatly assists the organization to retain its potential shareholders. This will further intensify the economic growth of the company. When an organization wishes to restructure its investment portfolio by divestiture, the company can reshape its management structure also. For instance; at the time of a divestiture, the company gets the option to revise its message to investors, stakeholders, and employees. This practice easily assists the organization to implement its newer strategies in place of weaker ones, and it would enable the firm to get additional economic benefits on the strength of newly implemented strategies. Hence, it is evident that a divestiture concept can strategically refresh an organization without involving in long phases of planning and implementation. Generally, divestiture aids a firm to improve shareholder value, profitability, core competences, and competitive performance. By strengthening core business competencies, it is possible for the business firm to improve its financial performance (Assurance and advisory services). Increased concentration on profitable business segments would help the organization to exercise different competition strategies such as price reduction and cash discounts. It will certainly increase the market reputation of the firm and thereby its financial performance. The estimated rates of risks that are associated with cash flow and earning of dilution generally seem below the actual market risk. Therefore, an effective divestiture helps the company to experience a rise in its stock price. In the opinion of Dranikoff, Koller, and Schneider (2002), an active divestiture strategy would aid the organization to maintain its long term health and profitability. They also point towards the economic benefits of increased shareholder value those result from a successful divestiture. The authors also recommend that the companies must consider divestiture strategies as a part of their business policies rather than in response to emergency situations. These finding and recommendation greatly support the above described literatures. The authors clearly describe how a divestiture would benefit an organization and to what extent. Kumar (2003) opines that the concept of divestiture would be very beneficial for the organizations to kill a brand methodically. The thoughtless disposal of a brand will certainly affect the business as it would annoy the loyal customers. Hence, the entire literature discussed above strongly support the divestiture concepts. Conclusion From the above discussion, it is evident that divestitures have positive wealth effects. Majority scholars are of the opinion that rise in shareholder value is the most fascinating feature of divestitures. As this strategy increases the shareholder values, it will assist the organizations to retain its potential shareholder with them. Similarly, this concept is beneficial for the companies to dispose unprofitable business sectors and thereby concentrate more on the potential business areas. This process will also help to discard the unprofitable business segments at the expense of profitable ones. This increased focus on fruitful business areas may augment the profitability of the firm which in turn would help the company to practice different techniques. Finally, in addition to organizational restructuring, this strategy will also help a company to modify its messages that are already given to employees, stakeholders, and investors. References Colak, G and Whited, T. M. (n.d.). “Spin-offs, Divestitures, and Conglomerate Investment”. Department of Finance, University of Wisconsin. 1-57. Retrieved from http://toni.marginalq.com/colakwhited.pdf Dittmar, A and Shivdasani, A. (2008). “Divestitures and divisional investment policies”. The Journal of Finance, VIII (6), 2711-2742. “Divesting for success: Strategies for building value, Assurance and advisory services”. (2002).The US member Firm of KPMG International. 1-22. Retrieved from http://www.kpmg.com.au/aci/docs/divesting-success.pdf Dranikoff, L., Koller, T and Schneider, A. (2002). “Divestiture: Strategy’s missing link”. Harvard Business Review. Hoskisson, R. E. , Johnson, R. A and Moesel, D. D. (1994). “Corporate divestiture intensity in restructuring firms: Effects of governance, strategy, and performance”. Academy of Management Journal, 37 (5), 1207-1251. Harrigan, K. R. (1981). “Deterrents to Divestiture”. Academy of Management Journal, 24, (2), 306-323. Kumar, N. (2003). “Kill a brand, keep a customer”. Harvard Business Review. Kiymaz, H. (June 22, 2006). “The impact of announced motives, financial distress, and industry affiliation on shareholders’ wealth: evidence from large sell-offs”. Quarterly Journal of Business and Economics. Retrieved from http://www.highbeam.com/doc/1G1-158150439.html Read More