Restructuring and Divestitures
Summary and Keywords
Growth strategies have long been a priority for executive leadership. However, growth can also create problems. Leaders may need to use restructuring and divestiture actions to regain control, improve transparency, and re-establish efficiency. Given that leaders benefit from having insights into the antecedents, processes, outcomes, and decisions associated with unwinding growth most effectively, it is essential to consider the body of knowledge that exists in strategic management on restructuring and divestiture. This review seeks to describe what is currently known and not known about restructuring and divestiture and will give future researchers some suggested directions for further developing knowledge about these expensive and risky actions. The assessment is organized round five key questions that have shaped the field’s literature base: Why do firms divest? How do firms divest? Do divestitures create value? What happens to the divested units? And what are some promising directions for future knowledge development? Afterwards, three challenges for knowledge development are presented: What is value creation and for whom does it matter? What to do about incomplete information? And, is there a need for integrating different levels of strategy? Overall, it is important to identify, develop, and analyze the conceptual models of restructuring and divestiture with the purpose of guiding future research to provide knowledge that decision-makers will find useful as they engage in restructuring and divestitures.
Corporate restructuring evokes images of raiders, break-ups, bust-ups, and dissolutions and often appears as headline news. This was the case in 2015, when Hewlett-Packard split into two independent firms, and in 2016, when Yahoo spun off Alibaba. Some of these actions reach into the billions of dollars: eBay’s spin-off of PayPal was valued at $49.16 billion in July 2015, and the two companies’ market values were recently assessed at approximately $33 billion and $45 billion, respectively. In addition, restructurings have been long been popular; Porter’s (1987) review of corporate acquisitions found that most were divested, often within just a few years after their purchase (see also Bergh, 1997; Boot, 1992; Kaplan & Weisbach, 1992). Since then, “the value of divestiture activity has increased significantly over time, from less than $100 billion in deal value in 1993 to over $500 billion in 2007 and has represented a third of all merger and acquisition activity by U.S. firms” (Brauer & Wiersema, 2012, p. 1472). And some reports have indicated that the numbers and financial value of restructurings and divestitures continue to rise (http://www.stockspinoffs.com).
Given their significance, it is important to assess the prevalence, and potential of the knowledge base on corporate restructuring and divestiture. Corporate restructuring is a broad concept encompassing organizational, financial, and portfolio elements (Bowman & Singh, 1993). It is necessary to understand what is known and not known and suggest ways to reduce the knowledge gap.
This article explores five questions pertaining to the portfolio side of corporate restructuring and divestiture: (1) Why do firms divest? (2) How do firms divest? (3) Do divestitures create value? (4) What happens to the divested units? (5) What are promising directions for future knowledge development? It describes knowledge development, identifies areas for further consideration, specifies interrelationships with other research streams, and, finally, draws the connections across the questions to offer three challenges for knowledge development.
Why Do Firms Divest?
The motives for and consequences of restructuring and divestiture actions have been discussed by Brauer (2006), Hamilton and Chow (1993), Johnson (1996), Kolev (2016), and Moschieri and Mair (2008). Perhaps the most comprehensive empirical test of divestiture motives was presented by Villalonga and McGahan (2005). Depicting divestitures as an alternative “governance choice” to alliances, their study includes several possible motives, encompassing resources, corporate governance, experience, diversification strategy, relatedness, size, and a range of internal factors.
Although these assessments provide excellent insights, and there has been considerable knowledge development of the drivers of restructuring and divestiture, an analysis reveals significant gaps and limitations that warrant attention and reconsideration.
One stream of research concentrates on the effects of environmental forces on divestitures. Several theories and concepts spanning industrial organization economics, resource dependence theory, threat-rigidity, managerial discretion, and transaction cost economics have been applied to explain why firms divest in response to environmental factors. Early arguments focused on how industry structural factors inhibit exit actions (Harrigan, 1981) and how environmental volatility could trigger divestitures (Bergh, 1998; Keats & Hitt, 1988). A popular assumption suggests a relationship where changes in environmental factors lead to organizational inefficiencies that in turn prompt managers to use divestitures. For example, when environmental uncertainty increases, the internal costs of managing a firm’s business holdings rise, creating a situation whereby the firm’s internal costs can exceed the marginal benefits of owning the firms (e.g., Bergh & Lawless, 1998; Jones & Hill, 1988; Williamson, 1985).
Others have applied the resource-dependence perspective in order to understand the impact of social pressures on divestitures. For instance, some research has examined why activists might try to convince managers to use divestitures to serve some larger social good, such as withdrawing investments in companies doing business in South Africa or Burma (Soule, Swaminthan, & Tihanyi, 2014). Some scholars have used the resource-dependence perspective to explain the divestiture of previously acquired businesses (Xia & Li, 2013). A related argument applies institutional theory to explain that managers might use divestitures to conform to societal expectations (Davis, Diekmann, & Tinsley, 1994). Durand and Vergne’s (2015) study of media attacks highlighted the role of legitimacy preservation in driving divestitures. Some studies have considered how ecological and evolutionary stages may affect divestiture (Chang, 1996; Ito, 1995; Rose & Ito, 2005); for example, Mitchell (1994) examined how business sales and age in evolving industries may become precursors to divestiture. Others have emphasized that ecological factors may drive divestitures (for a review, see Karim & Mitchell, 2000).
Some research has attempted to integrate views. Shimizu (2007) applied prospect theory, behavioral perspectives, and thread rigidity to link environmental pressures and opportunities to divestitures, and Fortune and Mitchell (2012) considered how industry and firm factors serve as joint antecedents to the divestiture outcome.
Scholars have also examined how the boundaries of the environment construct might impact divestiture actions and performance. Drawing from a herding perspective, Brauer and Wiersema (2012) examined whether the timing of a firm’s divestiture within larger divestiture waves might influence investor reactions to the action. Other studies relate environmental changes, especially growth opportunities through emerging economies and country development, to restructurings (Hoskisson, Cannella, Tihanyi, & Faraci, 2004; Hoskisson, Johnson, Tihanyi, & White, 2005; Makhija, 2004). Global dimensions of the firm’s environment appears particularly relevant to divestiture decisions (e.g., Berry, 2010; Hoskisson et al., 2004; Hurry, 1993). Within this depiction, Wan, Chen, and Yiu (2015) presented a framework that applied organizational image and identity to drive a firm’s propensity to use international divestitures.
In sum, environmental factors have long played an important role in motivating divestitures. However, considerable opportunity exists for learning more about this relationship. Theoretically speaking, new and different concepts, such as reputation, sense-making, and social capital, could offer novel contributions into network, behavioral, and competitive interpretations of a firm’s environment. The field’s knowledge base would also benefit from integrations of environmental with strategy levels (diversification, business), strategic resources, implementation modes (e.g., sell-offs, spin-offs), divestiture characteristics (size, relatedness, age, sales), and postdivestiture performance. Finally, inquiry into whether and when divestitures contribute to a successful adaptation to environmental pressures would help us understand the role utility divestitures play within the strategic management concept.
Research has produced several interesting insights into how corporate governance influences divestitures.
The dominant theoretical perspective linking corporate governance to restructuring and divestiture is agency theory. In general, advocates of this perspective argue that owners and managers have different self-interests (owners seek profit maximization, whereas managers prioritize firm size, employment through diversification, and raising their prestige), and depending on which of these parties is most able to exert their motivations, a firm’s diversification strategy will be shaped accordingly (Hill & Snell, 1988, 1989). When managers are most able to pursue theirs, a firm’s business holdings become highly diversified through unrelated acquisitions (Amihud & Lev, 1981), expanding beyond the point where investor returns are likely maximized. In these conditions, the firm’s market value may fall, management becomes depicted as not meeting shareholder objectives, and a takeover may occur. When owners can enforce discipline over the managers, divestitures follow (Denis & Kruse, 2000; Hoskisson & Turk, 1990; Gibbs, 1993).
Corporate governance includes several different actors, many of which have been related to divestiture actions. At the most general level, studies consider whether the role and composition of a firm’s board of directors might influence restructuring actions. Two studies represent the conventional thinking about how boards attempt to redress agency problems. First, Johnson, Hoskisson, and Hitt (1993) examined board involvement in restructuring, distinguishing whether divestiture was a response to the board in its oversight role or resulted from managers adopting divestitures as strategy-corrective actions. They argued that outside board members become involved in restructuring when managers do not, finding that boards of directors may pressure restructurings even when managers do not wish to do so. In addition, the use of independent directors may deflect the implied meaning of a takeover. However, Chatterjee, Harrison, and Bergh (2003) found that target firms managed by more independent board members were more likely to ignore failed takeover attempts and not refocus the firm’s strategy. This logic assumes that the outsiders have established internal efficiency and that strategic changes are not needed. Overall, director characteristics seem associated with a firm’s propensity to restructure and divest.
Other research has focused on ownership groups. One set of studies has considered the equity holdings of blockholders (5% equity stakes or larger), typically depicting such stockholdings as signals “that the firm is appropriately governed . . . [and] investors . . . are likely to prefer firms that have attracted blockholder ownership over those which have not” (Sanders & Boivie, 2004, p. 172). These larger owners are believed to exert discipline over managers and force changes to corporate strategies. Ownership holdings of outsiders (e.g., Hoskisson, Johnson, & Moesel, 1994) and managers (Denis, Denis, & Sarin, 1997) have been related to divestitures (Bethel & Liebeskind, 1993) and to whether the divestiture was conducted through sell-off or spin-off (Bergh & Sharp, 2015). Bergh (1995) found that the combined effects of outside director equity, outsiders, and blockholdings were associated with divestitures of small noncore and unrelated businesses. Similarly, other studies have reported that changes in ownership from public to private ownership forms have been associated with the use of divestitures to restore strategic focus and achieve increased efficiency (Seth & Easterwood, 1993). Finally, later research has considered family ownership. Feldman, Amit, and Villalonga (2016) found that family firms are less likely to engage in divestitures but tend to have higher performance afterward.
Overall, the vast majority of thinking on corporate governance and divestitures has been viewed through the lens of agency problems with empirical research focusing on reversing over-diversification, the composition of boards of directors, and ownership power. This inquiry is likely to expand and deepen. The combination of emerging markets, regulatory changes, and multinational firms suggests that not only will corporate governance constructs continue to warrant consideration, but the melding of environmental and governance factors may play a central role in understanding divestiture decision-making. Accordingly, research that spans geographical markets and governance challenges across countries will likely provide rich opportunities for future research. Some initial investigations suggest a fertile ground: Hoskisson et al. (2004) found that deregulation coupled with increasing competition led to divestitures. The removal of embedded inefficiencies that may have existed within competition-protected markets seems to be a promising venue for additional corporate governance research. More inquiry is needed.
The evolving research stream also recognizes that the governance actors have interdependencies. Some scholars have suggested that the components of corporate governance can be considered as substitutes for one another—that is, because of their common interest in aligning the interests of shareholders and managers, monitoring by large outside shareholders, by inside directors, and incentive effects of managerial equity can be construed as alternatives (Rediker & Seth, 1995). However, it is necessary to understand their interactions and inter-relationships to understand the nature of corporate governance through research that further examines connections between the maturity, characteristics, and interdependencies of the governance market and adopts other theoretical perspectives. Taking a promising new direction, Shen, Tang, and Chen’s (2014) model of firm status differentials in corporate takeovers moves the consideration away from agency problems to social factors. Similarly, because it employs upper-echelon perspectives to understand leadership decisions, executive retention has been found to influence acquisition outcomes (Cannella & Hambrick, 1993) and whether an acquired unit is retained or divested (Bergh, 2001). The role of strategic leaders within a governance setting and divestiture decision making remains under-explored.
Divestitures have long been considered a response to low firm performance (Duhaime & Grant, 1984; Hamilton & Chow, 1993), which typically arises from strategic problems. Divestitures are typically portrayed as changing firms’ strategies to “bring them back to their basics,” which generally means divesting noncore and peripheral businesses. A popular view suggests that when managers overdiversified their firms to pursue their self-interests (perhaps owing to weak governance), the firm exceeded some threshold point of optimal efficiency (Bergh & Lawless, 1998; Jones & Hill, 1988; Williamson, 1985), and divestitures were used to reduce the excessive diversification and bring the costs and benefits of the multidivisional form back into agreement (Markides, 1992, 1995). Another position argues that overdiversification can lead to a “diversification discount” that prompts divestitures to rid the firm of the units lowering its value (e.g., Ahn & Denis, 2004; Burch & Nanda, 2003; Villalonga, 2004). Further, conglomerates consist of individual units that cannot share specialized resources and thus cannot sow the kind of synergies that serve as the foundation for competitive advantage at the strategic business unit level (Montgomery & Wernerfelt, 1988; Shleifer & Vishny, 1991; Williams, Paez, & Sanders, 1988). Such firms tend to have the lowest performance (Rumelt, 1974, 1982) and not surprisingly frequently engage in divestitures. Finally, the systems used to manage highly diversified firms tend to focus on financial controls and internal profit centers—which emphasize internal discipline and no sharing among business units (Hill, Hitt, & Hoskisson, 1992; Hill & Hoskisson, 1987; Hoskisson, 1987), which would not contribute to the development of competitive advantages (Bergh, 1995). Although highly diversified firms have numerous benefits, many suffer problems that can only be reversed through divestiture.
Other studies focus on the relationships between acquisitions and divestitures. First, beginning with Porter (1987), and then applied by Boot (1992), Kaplan and Weisbach (1992), and Bergh (1997), divestitures are portrayed as “failed” acquisitions; those that did not meet expectations and were divested subsequently. Similarly, divestitures have long been depicted as emotionally challenging decisions (Hayward & Shimizu, 2006). Organizational inertia may raise the barriers to divesting an acquired business (Shimizu & Hitt, 2005), and it may take new executives to dispose of a founding and legacy business (Feldman, 2014). Second, some scholars depict divestitures in a different light, portraying them as selling unwanted parts of a larger acquired asset bundle (Capron, Dussauge, & Mitchell, 1998)to reconfigure a firm’s resources (Karim, 2006, 2009; Karim & Mitchell, 2000). From this perspective, acquisitions are a natural part of the resource development process, as managers trim off acquired assets that do not fit with the firm’s strategic direction. Overall, divestitures likely include failed acquisitions as well as actions to pare down acquired assets. This viewpoint of divesting previously acquired assets is appealing because it leverages the concepts of resources and competitive advantage, echoing Porter’s (1987) initial concern that divestitures occur because acquired assets do not make the firm better.
The relationship between firm strategy and divestitures is still ripe for for future research and knowledge development. First, research into the role of divestitures within resource configurations and business strategy is in its early stages. Understanding divestitures with respect to market positioning and strategic differentiation remains fresh and relatively unexplored. Second, even less knowledge exists on the linkages between corporate strategy, business strategy and divestitures. Research on divestitures has tended to focus on either diversification-level or firm resources, but not integrative of both. There is considerable need to understand how these two levels of strategy might motivate divestitures and in turn create value for the divesting firm. For instance, coordinating and merging theories at the diversification level with the business level would open new questions and ground to explore: does using divestiture to change corporate strategies also allow for improvements in business strategy? How do these divestitures increase value creation at both levels simultaneously? Further, are there trade-offs between the two levels of strategy that divestiture can be used to reconcile? Finally, reviews of the diversification-performance relationship reveal a nonlinear inverted U-shaped association, whereby mid-levels of diversification generally have higher performance levels than occupying positions at either low or higher points on the diversification spectrum (results summarized by Palich, Cardinal, & Miller, 2000). Understanding how divestitures might be used to change a firm’s strategy along the diversity spectrum might help us understand how the linkages between strategy and performance drive these actions.
How Do Firms Divest?
Once managers have decided to divest, the next step is to implement the action. The research thus far focuses primarily on the two most frequently used modes, which are sell-offs and spin-offs.
These actions are typically referred to as divestitures. Sell-offs involve assets sales from one firm to another; the divesting firm exchanges its ownership rights of some assets for cash and securities from a buying firm. To the firm making the divestiture, the proceeds are usually taxable, whereas to the buying firm, the divestiture represents an acquisition. Sell-offs are the most commonly used type of divestiture and tend to involve smaller and peripheral (i.e., noncore, unrelated) business lines (Bergh, 1995; Capron, Mitchell, & Swaminathan, 2001; Comment & Jarrell, 1995).
The motivations for sell-offs are equivalent to those commonly attributed to divestitures, spanning financial, strategic, corporate governance and environmental. In studies on the choice of sell-off over other modes, financial distress has been found to drive sell-offs (Duhaime & Grant, 1984; Hamilton & Chow, 1993), as the divesting firm can use the proceeds from the sell-off to pay down debt or interest or increase free cash flow). Indeed, sell-offs are typically framed as responses to low or underperformance (Bergh, 1997; Brauer, 2006; Hoskisson, Johnson, & Moesel, 1994).
Another motive is the “efficient deployment hypothesis,” where sell-offs are used to “promote efficiency by allocating assets to better uses and sellers capture some of the resulting gains . . . managers only retain assets for which they have a comparative advantage and sell assets as soon as another party can manage them more efficiently” (Lang, Poulsen, & Stulz, 1995, p. 4). Similarly, sell-offs may be used to minimize the opportunity costs of retaining resources that could be better sold and their proceeds applied to pursuing growth opportunities (Berry, 2010).
A popular vein of inquiry considers sell-offs as vehicles for refocusing a firm’s diversification strategy to a narrower set of related business holdings (Comment & Jarrell, 1995; Desai & Jain, 1999; Markides, 1992). Sell-offs also tend to be used when the divesting firm is ridding itself of unrelated and noncore businesses—Bergh, Johnson, & DeWitt (2008) argue that the value of such units may not be well known to the selling firm and that potential buyers may include competitors of divested units whom might have a knowledge advantage over the leaders of the divesting firm. Through conducting a sell-off in an open market of potential buyers (e.g., allowing multiple buying firms to compete as potential suitors), the selling firm could lower the abilities of more knowledgeable buyers to exploit opportunistically their potential knowledge advantages. In addition, learning from sell-off experience is also related to the adoption of subsequent sell-offs (Bergh & Lim, 2008). When forced to divest, managers may prefer sell-offs, since the proceeds can be used to fund growth and diversification and to further their own self-interests (Bergh, 1995; Bergh & Sharp, 2015; Berry, 2010).
In general, sell-offs serve as vehicles for refocusing to core businesses, shuttling assets to other firms and investing the attendant proceeds, lowering information asymmetries, capitalizing on learning benefits, and of course, reacting to potential pressures originating in corporate governance.
Though less frequent than sell-offs, spin-offs garner media attention because they often involve large, already established businesses that likely have investment implications. Spin-offs occur in a much different way than sell-offs, as with a spin-off, the divesting firm redistributes its ownership rights of a subsidiary or division to its equity holders. These kinds of divestitures have both similarities and differences with sell-offs.
Like sell-offs, spin-offs have been depicted as vehicles for refocusing, a “back to basics” approach (Daley, Mehrotra, & Sivakumar, 1997; Desai & Jain, 1999; Hite & Owers, 1983). Another similar motive is the “information hypothesis”—diversified firms can be overly complex, masking internal cash flows among internal divisions, and spin-offs may be used to improve the clarity of these internal cash flows, as well as to isolate the firm’s value-creation mechanisms (Krishnaswami & Subramaniam, 1999). Through using spin-offs to reduce diversified firms into “pure play investments,” the owner would have more information on the cash flow and financial prospects of each and could then make investment decisions accordingly (Bergh et al., 2008).
Spin-offs may also occur to facilitate continuing relationships among the divesting and divested businesses (Woo, Willard, & Daellenbach, 1992). They often involve business lines that have some relationship with the divesting firm’s core assets—such as suppliers or distributors—and contracts can be established before the divestiture occurs, providing opportunities for on-going postdivestiture relationships that benefit both parties (Bergh & Lim, 2008; Klein, Crawford, & Alchian, 1978). For example, General Motor’s spin-off of both Electronic Data Systems and Delphi Automotive would allow all three to operate independently but also continue on with their pre-divestiture activities, a necessity for Delphi who received nearly 100% of their revenues from their business with GM. Sell-offs, by contrast, would not likely afford such opportunities.
Other explanations focus on incentive alignments (Feldman, 2016a, c). In these studies, spin-offs have been depicted as methods for motivating managers to grow their initial corporate-owned businesses to an extent where that the business could succeed on its own (Aron, 1991; see also Ito, 1995; Ito & Rose, 1994). Similarly, some research considers spin-offs and buyouts as alternatives for commercializing innovations (Rubera & Tellis, 2014).
Firms also tend to use spin-offs over short-term bursts that resemble an improvisational adjustment to diversification strategies (Bergh & Lim, 2008). Later research has examined several facets associated with the governance and oversight of these new firms, including board of director membership, postdivestiture linkages with the parent firm, and executive compensation packages (Feldman, 2016a, b, c; Moschieri, 2011; Semadeni & Cannella, 2011).
Overall, knowledge of spin-off adoption is significantly underdeveloped and inquiry into the connections between motives and the use of these actions and their performance is needed. Despite improved insight into why and when they might be selected relative to sell-offs (see Bergh & Sharp, 2015, for a review), carveouts (Michaely & Shaw, 1995) and both (Slovin, Sushka, & Ferraro, 1995), much remains unknown. Understanding of the preferential adoption of spin-offs is quite limited.
A Word on Equity Carveouts
Also known as partial spin-offs, equity carveouts occur when part of the equity of a firm’s assets is issued to new shareholders. These actions can be viewed as “staged” divestitures (Damaraju, Barney, & Makhija, 2015; Makhija, 2004), whereby they occur prior to a larger spin-off or are subsequently repurchased through a buyback. Moschieri’s (2011) case studies illustrate how firms may use sell-offs, spin-offs and carveouts in combination with one another, even involving for the same asset base. At present, we know comparatively less about carveouts within the management literature and certainly considering their motivation, adoption and implications is promising. The finance literature has focused on their role as a divestiture alternative, the information they provide to outsiders, and their relationship with stockholder reactions to a divestiture announcement (see Vijh, 2002), but much on the strategic management aspects remains left to explore.
Overall, sell-offs, spin-offs and equity carveouts have different motivations. Our knowledge of restructuring and divestiture needs to recognize the distinct qualities, features and implications of sell-offs, spin-offs and carveouts. Research that examines the full set of divestiture motives, their linkages to divestiture alternatives, and then to postdivestiture performance would add to our knowledge of the divestiture process.
Do Divestitures Create Value?
The linkages between divestitures and value creation have mostly been portrayed within three theoretical perspectives including restoring efficiency by reducing transaction cost economic problems, realigning with owners’ interests in reducing agency costs, and exploiting firm resources to increase firm heterogeneity. In general terms, and as noted above, the “firm efficiency” model draws upon from Williamson’s (1975, 1985) conception of transaction cost economics whereby firms face limits to their growth and diversification. Divestitures create value through restoring internal efficiency (Bergh & Lawless, 1998; Hoskisson & Turk, 1990; Jones & Hill, 1988), and that it will experience future performance improvements (Markides, 1992, 1995). Another perspective draws from agency theory to specify that value creation will occur through reducing the diversified firm’s “discount” through stronger governance. Finally, the resource-based view states that divestitures will create value through redeploying and reconfiguring assets whose opportunity costs would be minimized and revenue prospects maximized in other uses (e.g., Berry, 2010; Capron et al., 1998, 2001). Divestitures create value through improving a firm’s stock of heterogeneous resources, contributing to the development of competitive advantage and producing higher financial performance (e.g., Karim & Mitchell, 2000).
In addition to the foregoing theoretical traditions, researchers are increasingly applying different lenses for probing how divestitures impact upon firm performance. These inquiries encompass the learning perspective, whereby value is created through leveraging knowledge gained from the experience curve (Bergh & Lim, 2008; Shimizu & Hitt, 2005; Villalonga & McGahan, 2005), integrating performance feedback and firm resources to help explain how divestitures reconfigure asset bases (Vidal & Mitchell, 2015), and applying behavioral theories to explain how compensation structures may induce or inhibit divestiture decisions (Sanders, 2001). Further, the upper echelons perspective has been used to explain how top management teams might manage strategic change (Wiersema & Bantel, 1992). Collectively, these diverse perspectives provide important insights while also revealing the breadth of opportunities for understanding the diverse dimensions of divestitures and how they create value.
Like most research streams, the literature on divestitures and performance presents mixed and contradictory findings (Vidal & Mitchell, 2015; Moschieri & Mair, 2008; Veld & Veld-Merkoulova, 2009). Some studies synthesize the empirical relationships and provide insights into patterns over the body of research.
Lee and Madhavan (2010) employ conventional meta-analytical techniques to aggregate and test the effect sizes (sample size weighted correlation coefficients) of the divestiture-performance relationship in some 90 empirical studies. They find that divestitures are related positively to financial performance, though moderation tests reveal that the linkage is contingent upon how performance is measured, the format of the transaction, the motivation, and the firm’s resource types. This study finds that for the body of surveyed literature, the divestiture and financial performance relationship is positive: they report an effect size of .16 and .10 for the associations between divestitures and accounting and market measures of performance, respectively.
Another examination of empirical studies focuses on spin-offs and their relationship with performance, typically considered in terms of stock-market returns. Veld and Veld-Merkoulova (2009) regression the reported abnormal returns from 26 studies appearing in the finance literature onto several motives and contextual variables (e.g., rank of journal). They concluded that “spin-offs are associated with strongly significant abnormal returns that range from 1.32% to 5.56%” (p. 409). Their findings indicate that the stock market returns are positively associated with spin-offs that increase the divesting firm’s industrial focus, those that capitalize on regulatory and tax advantages and are larger in size.
On balance, both assessments reveal positive relationships between divestiture and performance. Both also can be extended. Consider that Lee and Madhavan’s (2010) theoretical proxies and their corresponding empirical measures encompassed whether the disclosed motive was deemed strategic or tactical, the relatedness of the divested unit relative to the divesting firm’s core business, signaling through the voluntary disclosure of the selling price, and a dummy variable of the possession of adequate resource levels in terms of slack, experience, age, past performance, R&D level. However, this meta-analysis, as well as other literature reviews have recognized but not tested the multivariate relationships that exist within the divestiture process, such as linking motivating conditions to divestiture characteristics, then to divestiture implementation modes (sell-off, spin-off), and finally to value and performance.
Specifically, Lee and Madhavan (2010), through applying the conventional bivariate meta-analysis techniques, examined how strategic, implementation, and performance measurement proxies moderate the correlation between divestitures and performance. However, adopting a multivariate meta-analysis format can provide a new type of test of the divestiture relationships. Specifically, the unit of analysis in a meta-analysis, the effect size, can be computed among several variables, used as input into regression and structural equations modeling (meta-analytical structural equations modeling, or MASEM) and analyzed simultaneously. The MASEM technique employs meta-analysis to aggregate the literature’s empirical findings and then structural equations modeling to facilitate an empirical assessment of the field’s findings, such as the various theories of why firms divest, how those theories relate to how firms divest and then along to value creation. MASEM “redirects thinking from resolving inconsistencies in reported findings to expanding knowledge of the boundaries of phenomena and thinking . . . the antecedents to divestiture . . . could be related to divestiture, which would then be related to performance” (Bergh et al., 2016, p. 493). Applying this technique to the restructuring and divestiture literature would likely allow for a significant advance to understanding the comparative value of the motives and their relationships with performance.
What Happens to the Divested Unit?
Understanding the performance implications of divestiture has been extended to the divested unit. Although most divested businesses become absorbed into another firm through the sell-off format, spun-off units become independent, stand-alone entities. On balance, there is far less understanding of what happens to these businesses than of what happens to the divesting firm (Moschieri, 2011; Semadeni & Cannella, 2011). In concept, their newfound independence would allow them to pursue new revenue opportunities free from the parent firm’s bureaucracy and oversight. However, these businesses may lose access to their parent firm’s resources and would have to make the significant investments associated with surviving as a new business (Ito, 1995; Ito & Rose, 1994). So, we have ample reasons to be hopeful but also grounds for concerns about downward pressures on the performance of these firms.
Not surprisingly, the empirical relationships between spin-offs and performance are mixed. For example, Woo et al. (1992) document that spin-offs did not realize any higher returns than a comparison group of non-spin-offs and that these differences were not contingent on strategic relatedness (vertical, horizontal, etc.) with the divesting firm. By contrast, some studies in the finance literature document that spin-off firms enjoy positive stock market performance (see Veld & Veld-Merkoulova, 2009, for a review).
What is known about the drivers of spun-off firm performance is primarily based on their relationships with the divesting parent firm. Unlike other new firms, spin-offs previously existed within the parent firm as a subsidiary or division and through interactions may have been imprinted with the parent’s resources, processes and traditions (Hambrick & Stucker, 1999; Ito, 1995; Ito & Rose, 1994). Further, the divesting firm makes decisions on the spin-off’s name, board of directors, leadership, whether it will hold equity afterward, and post-divestiture relationships (Moschieri, 2011; Semadeni & Cannella, 2011), so it is not surprising to see that most research to date examines these possible endowments and commitments.
Seward and Walsh (1996) suggest that the implementation of parent internal controls to increase efficiency in the spin-off firm, including inside CEOs (those coming from the parent), the design of compensation contracts and having higher numbers of outsiders on the boards of directors, would reduce costs and improve performance. The positive investor reaction to spin-off announcements was interpreted as supporting these arguments. Semadeni and Cannella (2011) examine a different set of parent governance and monitoring factors and whether they contribute to higher longer term performance in the spun-off firm. However, their findings suggest that too much parent control can harm the spin-off firm’s performance. For example, having either a board member or a chairman from the parent is related positively to the unit’s financial performance. However, having both positions filled by parent firm executives is associated with lower performance. Also, the parent firm’s equity stakes may suppress the performance of these firms.
Moschieri’s (2011) case studies uncover similar trade-offs between parent control and independence. She notes that the units that had a greater sense of opportunity were likely to outperform those that did not, but that a tension exists between parent control and unit independence. She notes that “there may be a level of interdependence/autonomy that would be optimal for the parent and for the unit, where the advantages of granting the unit the opportunity for self-actualization and growth pay off the risks of separating its activities” (p. 389). It would seem that exploring this trade-off and understanding its properties is critical to developing the baseline of knowledge.
Most recently, Feldman (2016b), and Feldman and Montgomery (2015) found that the performance of spin-offs was difficult to forecast, perhaps given that as subsidiaries within diversified firms they exist outside of external assessments and observers have to make inferences about their futures. So, internal incentives become an important mechanism for encouraging the spin-off’s executives to take actions to maximize performance. Specifically, Feldman (2016c) considered whether incentive alignments that link the unit’s management with the stock market are associated with higher post-divestiture performance. She found that these incentives were related to higher performance when the spin-off had higher performance than the parent, was in an unrelated industry and its executives were previously associated with the spin-off rather than transferred from the parent. Further, Feldman (2016a) found that dual directors—those appearing on both the divesting and divested unit’s board of directors—appeared to suppress the unit’s performance as its sales increasingly depended more on the parent. On balance, these studies add further specificity about how the parent’s structuring of the relationship with the divested unit may impact upon its performance.
When considering the development of this stream of studies, unpacking predivestiture effects, decisions and post-divestiture relationships with respect to parent governance and monitoring represent important research topics. Expanding this consideration to other strategy-related topics would build upon these studies and contribute toward developing a more comprehensive explanatory framework. Such research would need to include environmental constructs and perhaps examine the interplay with the parent relationships (e.g., “nature versus nurture”). More is needed, too, on the resources and strategies of the spun-off firm—understanding the roles of their market positioning, business models, scope of operations—each of which is relatively unknown. Thus, going beyond parent post-divestiture relationships to include resources and industry factors would contribute toward understanding the outcomes of spun-off firms. Finally, recognizing that the spin-off divestiture involves two parties—the divesting firm and the divested unit—suggests that theory development in terms of divestiture motives, implementation processes and financial implications—have joint relationships that have received to date very little research attention. In particular, the two entities may have shared infrastructures, joint competences and had strong value-creating relationships that may be forever changed due to the divestiture. It is important to understand how divestitures impact upon these bonds and the subsequent impact on their fortunes afterward.
Directions for Future Knowledge Development
Our understanding of restructuring and divestiture is expanding in multiple ways. However, much remains unknown and promising opportunities exist to expand knowledge along theoretical and methodological dimensions.
Much of what is known of the motives, methods and implications of restructuring and divestiture actions is based on applications of agency, transaction cost economics, and resource-based view reasoning. Some studies have branched out to adopt other theoretical lenses and concepts. For example, learning and experience curves, behavioral views, and the options framework have each been applied to some part of the divestiture process. Other views remain to be considered. For example, the concept of social capital and the network methodology have received little extension to divestitures (Brauer, 2006). However, such an application would seem straightforward. For example, Gulati, Nohria, and Zaheer (2000) proposed that the networks among firms may have implications for industry structure, positioning, resource and capability development, contracting and coordinating costs, and dynamic constraints and benefits. Restructuring and divestitures could change industry structure by altering the networks of incumbent firms, such as severing relationships that arose from alliances or mergers among cooperating firms. Understanding how divestitures figure into the management of network relationships to develop and sustain competitive advantage would seem to be a fundamental issue worthy of exploration. In addition, research into the role that divestitures play in the formulation and management of a set of network ties also seems valuable. How divestitures might shape a firm’s portfolio of nonredundancies, frequency of interactions, and weak ties could all provide new insights into knowledge of the firm’s performance.
In addition, approaches that focus on developing the depth of popular perspectives would also have significant value-added potential. Knowledge development seems to have an exploration mindset seen in the adding of new constructs, logics, and relationships. Such inquiry is certainly valuable. But research that takes what is known and builds on it is also needed. Research on corporate governance has started to do some of this development through linking components of the governance environment (e.g., owners or boards of directors) with divestiture characteristics, then to divestiture implementation modes (sell-off, spin-off) and finally to performance. To develop more complete models, it will be important to link environmental and strategic dimensions to divestiture implementation to performance and to the units divested.
There is also considerable opportunity for examining the boundaries and integration of extant perspectives and the role of divestitures within these relationships. In particular, research that examines the overlaps of existing mainstream theories to understand their interplay seems highly promising. For example, two of the more popular theoretical perspectives used for examining divestitures, transaction cost economics and the resource-based view, make for an especially insightful marriage, as each addresses different motives and stages of the divestiture process. Examining their intersections illuminates opportunities for developing knowledge of the role that restructuring and divestitures may play in explaining a firm’s performance.
More specifically, Rumelt, Schendel, and Teece (1991) encourage scholars to produce “a coherent theory of effective internal coordination and resource allocation, of entrepreneurship and technological progress” (p. 19). This logic would suggest that divestitures play a two-part role: lowering internal coordination costs through removing ineffective resources and safeguards while also freeing up resources for entrepreneurial and innovative investments. Divestitures could therefore reduce governance inefficiencies while bolstering a firm’s source of heterogeneous resources.
Taking a similar perspective, Williamson (1999) compared “governance” and “competence” perspectives. He posited that the “firm as a whole is different from and larger than the sum of the parts . . . [and the governance perspective will] benefit from research in the competence tradition on holistic consequences” (p. 1102). He argues that both perspectives complement one another and notes several possible areas of overlap. Divestitures may play a role in the synthesis of these two traditions through facilitating governance efficiency and allowing managers to shape their resources to realize a uniqueness in their competence. This article by Williamson may foreshadow future research that seeks to combine the governance and competence views rather than view them independently, as past research has often tended to do.
More specifically, rather than simply focus on how divestitures shift the relationship with a divested unit to a particular transaction organizing mode (market, hybrid, hierarchy), the question becomes, how do divestitures also help firms develop their own heterogeneous competences? Divestitures could take the form of bolstering the firm’s preexisting comparative advantages, reducing its drawbacks, and helping it to maintain efficiency. Further, divestitures may also help reposition a firm to build up its core competencies and relieve the drawbacks on its organizing costs so that it can compete more effectively in the future.
A similar perspective could be applied to describe when divestitures might be used to integrate agency costs with other challenges facing strategic leaders. For example, linking agency theory and divestitures with a resource perspective could help provide a more comprehensive understanding of whether corporate governance’s power and pressure that leads to divestitures actually improves the firm’s performance. Further, despite that activist owners have been linked to divestitures in the press (e.g., Bergh & Sharp, 2015), there is little evidence on whether these owners and the divestitures they inspire have different performance implications than what we already know from research on blockholders and their links with divestiture and performance. It would seem that stockholders, regulators, and financiers would benefit quite significantly from knowing the implications of activist and other large owners. Are these owners and the divestitures they precipate beneficial for business, industry, and the economy?
One final suggestion for increasing the knowledge base of divestitures pertains to understanding the information asymmetry that exists between those that make decisions to divest and those that attempt to make sense of them. Quite frankly, those that make the divestiture decisions have more and better information than those that do not. In some cases, this information disadvantage can be considered within the firm (Bergh et al., 2008), while in other conceptions, it exists for those outside the firm, such as owners (Brauer & Wiersema, 2012; Krishnaswami & Subramaniam, 1999). Overall, the understanding of how this asymmetry is managed and what it means is underdeveloped and has long been omitted in theory development. For example, a stream of studies have regressed stock market reaction to a divestiture announcement onto some attribute of the divesting firm to supposedly capture the divestiture’s “value added.” In this construction, the authors have assumed that the stock market has value-able understanding of the divestiture’s situation at the time of the announcement. This condition, however, may be difficult to achieve in reality. For example, Feldman, Gilson, and Villalonga (2014) reported that financial-security analysts have substantial inaccuracies in predicting the performance of divesting and divested firms. Therefore, stock market studies may be examining a value-creating proxy that bears little resemblance to what actually happens to the divesting firm and its units. Developing the role of information asymmetries in restructuring and divestiture represent fertile grounds for researchers interested in uncovering how these actions influence value creation.
In sum, our knowledge of divestitures beyond transaction cost economics, the resource-based view, and agency theory perspectives is limited, so theorists have numerous opportunities to explore how the bridges of these and other theories may lead to corporate restructuring actions. Many theories have seen little application beyond an initial extension. And few models seem to build on existing relationships within the divestiture process.
Although progress has been made in restructuring and divestiture studies, such as distinguishing the different kinds of divestitures (e.g., sell-offs are not as often lumped with spin-offs), some additional revisions to methodological practices would contribute to the understanding of divestitures.
First, there is considerable variation in how divestitures and their performance implications have been measured. Consider that most theories specify a relationship with performance, while many if not most empirical measures of performance using either a market-value proxy, an accounting-based one (e.g., return on assets), or both. These arguments and measures are based on precedence within the literature. Perhaps a different approach to thinking, both conceptually and empirically, would bear additional fruit for the literature.
One of the most rigorous performance tests was reported by Woo et al. (1992). In their study, the authors used multiple and diverse measures, including the ratio of market to book value. This particular proxy presents interesting information: when it is above one, then the market value of the assets exceeds their book value, investments are encouraged, and economic rents were created; a value of one means an equilibrium point has been reached; and values below one indicate that no investment in the firm is warranted because its book value exceeds the market’s assessment of the firm’s worth. Most commonly considered within what is known as “Tobin’s q,” this performance measure helps capture when economic rents are realized (see Montgomery & Wernerfelt, 1988). It further helps capture intangible value, whereas most other proxies do not. Finally, managers may use divestitures to directly manipulate the q value; if the ratio is less than one, then incentives for a takeover exist and managers could lose their positions. So, by removing underperforming assets, generating increased stock price by the investment community, and thereby raising the q value, managers would seem to be creating a takeover wall protecting their firms.
Stepping back, relating explanations of restructuring and divestitures to measures of economic rents would further our understanding of why, when and how these relationships create value. While the current practice of focusing on market or accounting-based practices is understandable, the depiction misses a larger point of understanding when divesting firms or their spin-offs create real economic rents, when they do not, and how and what factors are associated with increasing or decreasing rents, and so on. More specifically, considering only stock-price performance, then the focus is on market value only. Similarly, if a study uses only an accounting-based measure of performance, then it is subject to nonstrategic decisions that could distort its meaning (e.g., reducing costs through redundancy eliminations could decrease the numerator and raise the overall margins). Instead, considering both market and book value relative to one another could open new ways of theorizing about divestitures, not just explaining when performance is higher or lower but also when the market value rises more than the book value of the assets.
Second, another methodological concern pertains to endogeneity due to sample selection bias. Few studies on divestitures include a comparison group, although such practices have long been applied (e.g., Woo et al., 1992). Firms that restructure and divest represent a subsample of firms that are likely to differ from the larger population, so controlling for those differences is important. Including a matched sample of restructuring and nondivesting firms in a Heckman two-stage analytical model would seem to be a basic requirement; the first stage regresses the sample membership (the firm was a member of the divestiture sample or the nondivestiture sample) onto a list of variables, at least two of which (known as exclusion variables) would not be related to the performance measure in the second phase of analyses. These analyses should also be conducted for spun-off firms, though the process may be less clear. One approach would be to find comparable business segments that were not restructured and divested and put them into a population group. This process would include identifying the universe of business segments, eliminating those involved in spin-offs, and then using either a propensity score or a matching model to create a comparison sample. Feldman (2016a) provides an excellent primer on the steps and stages in such an analysis.
Although these techniques are recommended, it is also important to recognize that the two-stage analytical techniques come with drawbacks and limitations, such as the subjective selection of instrumental variables (personal correspondence with Emilie Feldman, January 22, 2016). Researchers need to exercise great care in developing comparable matched samples so that meaningful differences can be identified and applied to understanding the limitations in the findings (indeed, the endogeneity “cure” may be worse than the “disease,” personal correspondence with Matt Semadeni, July 28, 2014). One example is Damaraju et al. (2015) who reported a comparison group of nondivesting firms to their divesting firm sample. These side-by-side evaluations allow for insights into whether and when study results might be constrained by sample selection effects.
Finally, the research designs warrant attention, especially the justification of control variables. The selection and justification of controls often seems to represent convenient proxies available through data sources the researchers have at their disposal. However, the purpose of the controls is to account empirically for alternative theoretical explanations. Thus, if a study is testing motives, then having empirical controls for the other motives allows for the detection of the marginal or additional effects of the proposed motives. In general terms, control variables have often been misused (Atinc, Simmering, & Kroll, 2012; Carlson & Wu, 2012; Specter & Brannick, 2011), so being aware of problematic practices can allow for restructuring and divestiture researchers to develop stronger designs and, presumably, stronger and more robust empirical findings.
Finally, fine-grained case study research methods have much to offer the divestiture literature, particularly with the purposes of deriving new theory and hypothesis development. Harrigan’s (1983) is an exemplar in this regard and serves as a foundational piece. Other case study research efforts into divestitures (e.g., Moschieri, 2011) is also illuminating, but new theory development through inductive research could move the divestiture literature forward in a nonincremental manner.
Three “big question” challenges can help add clarity moving forward and in addressing critical limitations in current thinking and knowledge.
Challenge 1: Value-Creation and for Whom Does It Matter?
Knowledge of restructuring and divestitures has largely been driven by and based on financial antecedents and consequences. Most empirical studies tend to fall into one of two tracks: (1) value is presented as the stock market’s reaction as evidenced through a change in stock prices during some event window and (2) the firm’s postdivestiture financial performance (e.g., Lee & Madhavan, 2010).
Within strategic management more generally, such efficiency and profit maximization orientations are increasingly being augmented with implications for societies and communities. Divestitures are no exception. Therefore, the first challenge is to develop a clearer understanding of value creation aside from the overriding emphasis on financial performance. Distinguishing value creation from financial performance needs to take place in order to really know whether divestitures make the firm and its stakeholders better off.
The first challenge is to consider value creation within a multidimensional construction of the consequences of divestitures. While some research has examined social pressures on divestiture actions (e.g., Soule et al., 2014), even linking those actions to financial performance (e.g., Wright & Ferris, 1997), very little is known about the value for the community, the society and the customer. Including these groups in theory development will help in understanding the implications for them. Can a balanced scorecard be applied to divestitures? What trade-offs exist between stakeholder value and divestiture decisions? Research that examines the boundaries and integration of the performance and stakeholder literatures would be well positioned to move the understanding of divestitures into the future challenges facing executives.
Challenge 2: What to Do about Incomplete Information?
A significant premise in most theoretical explanations and descriptions of divestitures is the assumption of complete information. Consider that a firm’s motivations for a divestiture are presented by the firm itself. It is not known if the disclosed reason is the complete and honest truth, since it is not possible to directly observe the divestiture decision and therefore necessary to rely on reasoned deductions. Much if not most of the knowledge base is predicated on empirical associations that are used to support explanations that assume perfect information.
The second challenge is to examine whether understanding of the divestiture-performance relationships stands up to variations in information asymmetry. Stated in empirical terms, if the generally accepted relationships in the field’s literature are subjected to moderators of information asymmetry, do the key associations hold consistently? It is necessary to re-examine mainstream beliefs about the effects of divestitures and consider whether they exist once information asymmetry is included in the explanations and tests. If information asymmetry influences the accepted relationships, then it may be necessary to reconsider the existing body of knowledge and what it means.
Challenge 3: Integration of Strategy Levels
The third challenge is to expand the definition of strategy and the role of divestitures within it. Most understanding of divestitures has developed either on the corporate-diversification level or the resource-configuration level. However, strategists make decisions at both the corporate and business level, so an integrative construction of strategy should follow to more closely align research with practice.
Divestitures can be cast as shaping both the corporate level of strategy through achieving governance and organizing efficiency while also impacting upon the firm’s sources of competitive advantage and influencing outcomes within its marketplace. There are significant research streams developing on the governance and competence views but little integration of the two. But this needs to be done, as corporate and business strategy both have important implications for firm performance (see Bowman & Helfat, 2001, for a summary). The role of divestiture in managing, linking, and improving both corporate- and business-level strategy represents a significant path forward for understanding restructuring and divestitures and indeed, the value of these actions. Research that examines the intersections and overlaps of the organizing and competence literatures would significantly move the understanding of theory and practice forward.
More than 35 years of study and observation have revealed that restructuring and divestiture are not the mirror opposites of acquisitions (Brauer, 2006), and that they involve their own unique motives, linkages, implementation modes, and afterlife. Thus, while much can be learned from the acquisition literature, especially since it is a more mature research stream, more thinking about the models of restructuring and divestiture, of what value really means and for whom; more questioning of underlying assumptions; and more work on developing an integrative model and process of divestitures are needed. The explanations thus derived offer rich insights into what is certainly a most significant action to all parties involved. Much more remains to be learned.
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