Comparing acquisitions and divestitures

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Abstract

We study the acquisition and divestiture activity of a sample of 1305 firms from 59 industries during the 1990–1999 period. Consistent with the importance of restructuring activity during the 1990s, we find that half of the sample firms are acquired or engage in a major divestiture. Consistent with the notion that economic change is a source of the observed restructuring activity, we find significant industry clustering in both acquisitions and divestitures. We also study the announcement effects of the two forms of restructuring and find that both acquisitions and divestitures in the 1990s increase shareholder wealth. Moreover, the wealth effects for both acquisitions and divestitures are directly related to the relative size of the event. The symmetric, positive wealth effects for acquisitions and divestitures are consistent with a synergistic explanation for both forms of restructuring and are inconsistent with nonsynergistic models based on entrenchment, empire building and hubris.

Introduction

In this paper, we study the causes and effects of acquisitions and divestitures during the 1990s. The general purpose of our analysis is to bring new evidence to bear on the contrasting views of corporate restructuring that have been presented in research on earlier time periods.1 We study whether corporate restructuring can best be typified as an efficient response to economic shocks or instead is better described as an imperfect reaction to management entrenchment and hubris.

Our initial analysis gauges the impact of economic shocks on corporate restructuring activity by studying whether there are industry patterns in acquisitions and divestitures. We follow the premise of recent studies of merger patterns by Mitchell and Mulherin (1996) and Andrade and Stafford (1999) that the clustering of restructuring activity in particular industries emanates from fundamental economic shocks. Our work can be distinguished from the other research by our emphasis on the 1990s and by our consideration of both acquisitions and divestitures. Consistent with the importance of economic shocks for restructuring activity, we find that both acquisitions and divestitures exhibit significant industry clustering.

To more directly determine the importance of economic shocks for acquisitions and divestitures, the main body of the paper uses event study analysis to empirically distinguish between two broad sets of theories of corporate restructuring: the nonsynergistic theory and the synergistic theory. The joint consideration of acquisitions and divestitures facilitates more refined tests of the two theories than can be attained by studying either acquisitions or divestitures in isolation. In particular, we study whether acquisitions and divestitures have an asymmetric or symmetric effect on shareholder wealth.

The first set of models that we test can collectively be labeled the nonsynergistic theory. These include models based on management entrenchment, empire building, and managerial hubris (see, e.g., Jensen, 1986, Roll, 1986, Shleifer and Vishny, 1989). Although differing in assumptions and emphasis, these theories generally predict an asymmetric relation between the wealth effects of acquisitions and divestitures. In the models, divestitures create wealth by increasing specialization and reducing agency costs, while acquisitions lower wealth by protecting management from market forces and by lessening corporate focus.

A second set of theories poses synergistic reasons for both acquisitions and divestitures. The origin of this line of thought is usually traced to Coase (1937) who theorizes that the size of the firm responds over time to factors that affect the relative costs of market pricing and internal management decisions. As an example, Coase (1937, Footnotes 31 and 32) argues that technological change will alter the efficient size of the firm and, by implication, affect the decision to engage in acquisitions or divestitures. Subsequent analysis has extended these insights. Klein et al. (1978) argue that acquisitions and divestitures represent reactions to changes in the transaction costs created by specialized assets. Bradley et al. (1988, p. 4) posit that mergers occur when bidding firms attempt “to exploit a profit opportunity created by a change in economic conditions.” Jensen (1993) more specifically relates the restructuring activity of the 1980s to changes in technology, input prices, and regulation. In contrast to the nonsynergistic theory, the synergistic models predict that both acquisitions and divestitures create wealth.

We test the predictions of the nonsynergistic and synergistic theories by studying the announcement effects of acquisitions and divestitures during the 1990s. We find that both acquisitions and divestitures create wealth. Moreover, the wealth effects for acquisitions and divestitures are directly related to the size of the restructuring event. The symmetric, positive wealth effects for both acquisitions and divestitures are consistent with a synergistic explanation for the two restructuring events and are inconsistent with nonsynergistic models based on management entrenchment, empire building, and hubris.

The sample used in our analysis is described in the following section. Section 3 characterizes the overall restructuring activity for the sample firms during the 1990s and Section 4 reports the industry patterns in acquisitions and divestitures. The fifth section presents the evidence on wealth effects. The final section summarizes the results and offers concluding comments.

Section snippets

The sample

The intent of our analysis is to study the causes and effects of acquisitions and divestitures during the 1990s. To implement our research design, we begin with a sample of firms covered by the Value Line Investment Survey and track their restructuring activity between 1990 and 1999. Our general procedure bears resemblance to recent research, such as Mitchell and Mulherin (1996) and Andrade and Stafford (1999), and allows us to estimate the rate of acquisitions and divestitures both in

Overall acquisition and divestiture activity in the 1990s

For each of the sample firms, we track acquisition and divestiture activity during the 1990s. Relying on the Wall Street Journal Index, Lexis/Nexis, Mergers and Acquisitions, and other financial and news media, we determine whether and when a sample firm is acquired. Using the same sources, we also determine whether a sample firm engaged in any major divestitures, including corporate spinoffs, equity carve-outs and asset sales. The spinoffs and carve-outs in the sample are readily classifiable.

Acquisition and divestiture activity by industry

We next estimate whether there are industry patterns in the rate of acquisition and divestiture activity during the 1990s. Our analysis is motivated by the theory of the firm (e.g., Coase, 1937), which argues that firm size responds to changing economic conditions. Subsequent theory by Jensen (1993) more specifically relates corporate restructuring to changes in technology, input prices and regulation. Mitchell and Mulherin (1996) support the theory of the firm by finding significant patterns

Wealth effects of acquisitions and divestitures

A large body of research has studied the wealth effects of acquisitions and divestitures. Much of the research on acquisitions is reviewed by Jensen and Ruback (1983) and Jarrell et al. (1988). The Appendix A to this paper notes some of the more recent research on acquisitions as well as selected research on divestitures.

In this section, we expand on the prior work by estimating the wealth effects of acquisitions and divestitures in the 1990s. Our joint consideration of acquisitions and

Summary and concluding comments

In this paper, we compare the acquisition and divestiture activity of a sample of 1305 firms from 59 industries in the 1990–1999 period. We find a significant occurrence of these two forms of restructuring during the 1990s. Roughly half of the sample firms are acquired or engage in a major divestiture in the sample period.

We also find significant industry clustering in acquisition and divestiture activity during the 1990s. Consistent with results for the 1980s, we find that acquisition activity

Acknowledgements

We thank Ted Boone, Laura Field, Gordon Hanka, Kathy Kahle, Bill Kracaw, Jeff Netter, Kim Rodgers, Dennis Sheehan, and seminar participants at the University of South Florida for comments on prior drafts. We especially acknowledge the detailed comments and suggestions provided by Mike Ryngaert.

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