2 Divestiture Motives (S. 5-6)

A number of different motives for divestitures have been proposed in prior research. These motives will be introduced in the following section, separated into motives for all types of divestitures (Section 2.1) and motives for individual types of divestitures, e.g. sell-offs, spin-offs, or equity carve-outs (Section 2.2). Previous studies have emphasized the motives for divestitures as determinants of the stock market reaction to the announcement of divestitures (Clubb &, Stouraitis, 2002) since investors anticipate the targeted economic benefits underlying the divestiture motives and voice this anticipation of economic gains through their reaction to the announcement (John &, Ofek, 1995). Depicting the motives for financial gains serves as a contrast to the pursued institutional approach in this study.

2.1 Motives for all Types of Divestitures

A dominant motive for all types of divestitures is increasing the focus of the parent firm (e.g., Berger &, Ofek, 1995, Comment &, Jarrell, 1995, Daley, Mehrotra, &, Sivakumar, 1997, Hoskisson &, Turk, 1990, John &, Ofek, 1995). Two reasons have been mentioned in prior literature to be responsible for divestitures of unrelated units: improved investment efficiency and improved management. Focus-increasing divestitures lead to improvements in investment efficiency by reducing the possibilities for distorted investment allocations within the firm (Ahn &, Denis, 2004, Gertner, Powers, &, Scharfstein, 2002, McNeil &, Moore, 2005).

This implication of divestitures builds on the notion that diversified firms destroy value because they invest too much in some business units and/or too little in others (Rajan, Servaes, &, Zingales, 2000, Scharfstein &, Stein, 2000, Shin &, Stulz, 1998). These misallocations have been used to explain why, on average, conglomerate firms trade at a discount when they are compared to a portfolio of single-segment firms in the same industries (Berger &, Ofek, 1995, Lang &, Stulz, 1994, Lins &, Servaes, 1999, Servaes, 1996).1 Scharfstein and Stein (2000) suggested two basic ways in which investment inefficiencies can arise:

First, managers in the diversified firm have greater opportunities to undertake projects as well as greater resources to pursue them. When managers have a tendency to overinvest out of free cash flow (Jensen, 1986, 1993) or to build ‘empires’ (Murphy, 1985, Tosi &, Gomez- Mejia, 1989), conglomerates may lead to overinvestment. Alternatively, Scharfstein and Stein (2000) proposed that even if conglomerates do not have more cash flow to distribute, their internal capital markets lead to a less efficient allocation of resources than would external capital markets. Instead, they encourage inefficient cross-subsidization from better to poorly performing units. This occurs when managers of weaker divisions engage in wasteful rentseeking activities in order to increase their bargaining power for negotiating compensation packages with the CEO.

Divestitures dismantle existing internal capital markets by changing the agents and mechanisms that influence the intra-firm allocation of capital (McNeil &, Moore, 2005). Based on a decrease of the free cash flow available to managers and a reduction of the possibilities of cross-subsidization, the divestiture of unrelated units leads to improvements in the internal allocation of capital (Ahn &, Denis, 2004, Burch &, Nanda, 2003, Gertner et al., 2002, McNeil &, Moore, 2005).