Asset sales and takeover threats

Abstract

This research addresses the question of whether the existence of a recent takeover threat affects the market reaction to a subsequent sale of assets. The effect of a prior takeover threat on the stock price reaction to an asset sale is examined from the perspective of both the buying firm and the selling firm. The total gains to the transaction are estimated as a market weighted average of the abnormal returns to the two firms. The results show that when there has not been a recent takeover threat on the selling firm, abnormal returns are significantly positive for the seller, the buyer and in total. However, if the selling firm has faced a takeover threat within the previous year, the abnormal returns upon announcement of an asset sale are insignificant for the seller, negative for the buyer, and negative for a portfolio of the two. Hence, the market has a lower estimate of the overall gains in transactions that follow takeover threats on the selling firm; in fact, these transactions result in a net wealth reduction.

Introduction

Previous research on asset sales between firms has found that shareholders of selling firms experience gains upon announcement of a sale (e.g., Hearth & Zaima, 1984, Klein, 1986) while the results for buying firms are mixed, with some studies (e.g., Jain, 1985, Rosenfeld, 1984) finding significantly positive gains and others (e.g., John & Ofek, 1995, Sicherman & Pettway, 1987, Zaima & Hearth, 1985) finding insignificant gains. However, there is only limited research studying both sides of an asset sale simultaneously.

While gains to sellers are positive on average, there is considerable cross-sectional variation. The circumstances under which a firm conducts a sale of assets can have an effect on the type of assets divested, on the reservation price required, as well as on how the market perceives the sale. For instance, Rosenfeld (1984), Hearth and Zaima (1984), and Sicherman and Pettway (1992) find that abnormal returns are lower for selling firms in relatively poor financial health. The purpose of this study is to examine the market’s reaction to an asset sale that follows a takeover threat. As outlined below, there are a number of reasons that a takeover threat may affect the way in which a subsequent asset sale is conducted. Further, the effect is examined from both the selling and the buying firms’ perspectives.

The market’s reaction to an asset sale could be different following a takeover threat for a number of reasons. First, as per Bhagat, Shleifer, and Vishny (1990), the firm could be conducting efficiency enhancing asset sales because of the pressure from a takeover threat. This would increase firm value and possibly preempt a takeover. Second, because of the pressure inherent in a threat of takeover, the firm may sell assets for a lower price than it would otherwise. Donaldson (1990) states that “under the fire of hostile attack … companies can and do divest hundreds of millions of dollars of going concern value. But a fire sale puts the vendor in an impossible bargaining position.” Along a similar vein, Pulvino (1998) finds that airlines selling used aircraft receive lower prices when they are in poorer financial health. Pressure from the market for corporate control may therefore result in asset sales transferring wealth from seller to buyer. Third, takeover threats may result in firms selling assets to avoid a takeover, but not by increasing efficiency. For instance, the crown jewels defense involves selling the assets that are attracting bidders, even if current management is first best. This hypothesis suggests that the total gains available in an asset sale¹ will be lower if the sale follows a takeover threat. Fourth, there may be no difference in the sales themselves, but the stock price of the selling firm may be reduced because of a decline in the expected takeover premium. Examining asset sales from the perspective of both the buyer and seller (as well as overall) will allow us to more clearly distinguish between each of these effects.

Previous researchers have examined the effect of the market for corporate control on asset sales. Bhagat et al. (1990) use a sample of 62 takeover targets to examine the differences in postoffer divestitures for firms successfully taken over and firms surviving a hostile threat. They find that firms which survive a hostile takeover bid subsequently divest the same amount of assets (measured as a fraction of the offer price) as do successful bidders. Bhagat et al. (1990) state that “firms escaping the takeover often do most of the things that the acquirer would have done anyway.” One implication is that the threat of takeover induces firms to make efficiency enhancing divestitures. However, the Bhagat et al. (1990) study examines only the dollar amount of assets divested and does not examine the market’s estimate (i.e., abnormal returns) of the value those transactions. Loh and Rathinasamy (1997) study the effect of a recent implementation of an antitakeover device on the market reaction to an asset sale. They find that firms that have not recently adopted antitakeover devices have significantly positive abnormal returns upon announcement of a selloff, while those that have adopted antitakeover devices receive insignificant returns. They conclude that an antitakeover device “alters investor perceptions about the management’s intention” with regard to future actions, including asset sales. Finally, Datta and Iskandar-Datta (1996) show that voluntary asset sales undertaken to fend off a takeover threat result in a wealth reduction for the divesting firm’s shareholders and bondholders.

This study expands on previous research in two ways. First, it looks at the effects of both a recent implementation of a takeover defense and a recent takeover threat. Both of these cases may indicate that management feels pressure from the market for corporate control, which may change the way in which the market interprets asset sales. Second, asset sales are examined from three different perspectives: gains to the seller’s stockholders, to the buyer’s stockholders, and equity gains to the transaction as a whole.² By utilizing a sample consisting of asset sales for which return data on both the selling firm and the buying firm is available, the market’s reaction to the sale can be measured for both firms. This type of sample allows us to estimate the total equity gains across both firms. This “total equity return” is used as a proxy for the market’s estimate of the total gains available in the transaction. The returns to each individual firm in a transaction can be affected by both the total available gains to the transaction, and by the way in which those gains are divided between the firms. Examining the equity returns to both firms and in total allows us to better distinguish between wealth transfer effects and differences in the total level of available gains. Sicherman and Pettway (1992) use a sample of buyers and sellers from the same transactions to show that both buyers and sellers experience higher gains when a price for the asset is publicly disclosed, and the sellers receive lower gains when they have recently experienced a credit downgrade. However, they do not examine variation in the total equity returns to the transaction. An examination of total equity returns in this context will not only add to the literature on asset sales, but may also help shed light on the role of takeover threats in the efficient allocation of corporate assets.

The results show that across the entire sample, average abnormal returns are significantly positive for both selling firms and buying firms upon announcement of an asset sale. When the selling firm has not been the subject of a takeover threat in the year prior to the sale, the results are the same as for the sample as a whole. However, when the seller has recently been threatened, the seller experiences no gains and the buyer experiences significantly negative abnormal returns. The average total equity gain (buyer plus seller) to a transaction is significantly negative when the selling firm has faced a takeover threat. The results hold when controlling for the financial health of the firms, the size of the transaction, and whether the transaction is part of an ongoing program of divestitures (or purchases). The main conclusion is that the threat of takeover does affect the market’s reaction to an announcement of a sale of assets. However, the effect is different than may previously have been supposed. On average, asset sales following takeover threats have lower total equity gains and most of this reduction is absorbed by the buyer. The results indicate, in contrast to previous work (e.g., Bhagat et al., 1990), that pressure from the market for corporate control does not necessarily result in firms making efficiency enhancing divestitures. As well, since the buyer fares the worst in cases where the seller has been under a takeover threat, it seems that the pressure of a takeover threat does not reduce a selling firm’s bargaining power. A takeover threat may, in fact, provide an incentive for management to bargain harder when selling assets.

The rest of the paper is organized as follows: Section 2 details the sample used and methodology employed, Section 3 presents the results, and Section 4 provides concluding remarks.