The economic causes and consequences of corporate divestiture

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The economic causes and consequences of corporate divestiture

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Myeong-Hyeon Cho (Korea University, Seoul, Korea)
Mark A. Cohen (Vanderbilt University, Nashville, USA)

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Mark A. Cohen

Abstract

This study investigates economic causes and consequences of large corporate divestitures between 1983 and 1987. Prior empirical evidence suggests that firms hold on to poorly performing operating units for many years before divestiture. An agency-cost explanation for 'holding on to losers' has been proposed in the literature, as managers may be unwilling to admit they invested in inappropriate asset choices in the first place. However, a puzzle still remains: why should such a manager ever sell off such a unit? We provide both a possible explanation and empirical evidence that suggests managers hold on to losers as long as they can 'blur' their poor performance under the cover of the remaining operating units of the firm. We find that firms do not sell off poorly performing business units until the firm's other units experience significant underperformance relative to their industry peers. Finally, although there is evidence that the stock market reacts favorably to divestitures, we find that beyond the initial improvement, the firm's performance reverts back to its mean pre-divestiture level.© 1997 John Wiley & Sons, Ltd.

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Article provided by John Wiley & Sons, Ltd. in its journal Managerial and Decision Economics.

Volume (Year): 18 (1997)
Issue (Month): 5 ()
Pages: 367-374
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Handle: RePEc:wly:mgtdec:v:18:y:1997:i:5:p:367-374

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Panos Desyllas, 2009. "Improving performance through vertical disintegration: evidence from UK manufacturing firms," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 30(5), pages 307-324. [Downloadable!]
Kwoka, J. & Ozturk, S. & Pollitt, M.G., 2008. "Divestiture Policy and Operating Efficiency in U.S. Electric Power Distribution," Cambridge Working Papers in Economics 0835, Faculty of Economics, University of Cambridge. [Downloadable!]

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