Financial Distress, Asset Sales, and Lender Monitoring Author(s): M. Ameziane Lasfer, Puliyur S. Sudarsanam and Richard J. Taffler Source: Financial Management, Vol. 25, No. 3, Special Issue: European Corporate Finance (Autumn, 1996), pp. 57-66 Published by: Wiley on behalf of the Financial Management Association International Stable URL: http://www.jstor.org/stable/3665808 . Accessed: 01/07/2014 06:59 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. . Wiley and Financial Management Association International are collaborating with JSTOR to digitize, preserve and extend access to Financial Management. http://www.jstor.org This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:59:03 AM All use subject to JSTOR Terms and Conditions
Transcript
Financial Distress, Asset Sales, and Lender MonitoringAuthor(s): M. Ameziane Lasfer, Puliyur S. Sudarsanam and Richard J. TafflerSource: Financial Management, Vol. 25, No. 3, Special Issue: European Corporate Finance(Autumn, 1996), pp. 57-66Published by: Wiley on behalf of the Financial Management Association InternationalStable URL: http://www.jstor.org/stable/3665808 .
Accessed: 01/07/2014 06:59
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .http://www.jstor.org/page/info/about/policies/terms.jsp
.JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range ofcontent in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new formsof scholarship. For more information about JSTOR, please contact [email protected].
.
Wiley and Financial Management Association International are collaborating with JSTOR to digitize, preserveand extend access to Financial Management.
http://www.jstor.org
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M. Ameziane Lasfer, Puliyur S. Sudarsanam, and Richard J. Taffler
M. Ameziane Lasfer is Lecturer in Finance, Puliyur S. Sudarsanam is Professor of Finance and Accounting, and Richard J. Taffler is Professor of Accounting and Finance at the City University Business School, London.
This paper examines the differing reactions of the stock market to divestments by financially distressed and healthy firms, and the impact of lender monitoring on that reaction. For a sample of UK divestors we find excess returns at the time of sell-off announcements are positive and statistically significant, but are far higher for financially distressed firms. These higher returns appear to be an adjustment for reduction in financial distress costs. Consistent with efficient lender monitoring, significantly higher returns are associated with higher levels of debt, especially in the case of distressed firms. The paper concludes that, in the UK at least, the main benefit from divestitures comes from the resolution of financial distress.
M A number of factors that motivate company management to undertake divestments affect share
price. In many cases, divestments are undertaken by companies as a means of transforming their business
portfolio. In others, they are designed to steer the
company out of potential bankruptcy (Ofek, 1993). Stock market reaction to the divestment announcement and the consequent change in shareholder wealth reflect the motive behind the divestment decision.
This study compares the stock price reaction to divestment decisions announced by both financially distressed and financially healthy firms. By focusing explicitly on bankruptcy risk, it extends previous work on stock market reaction to voluntary sell-offs.
In particular, we explore whether divestments by distressed firms are a means for regaining financial
strength. We examine whether such activity leads to shareholder wealth enhancement through the avoidance of direct and indirect costs associated with potential bankruptcy. We also look at the impact of lender monitoring on stock market reaction. Finally we control for other characteristics of the divestment announcement, viz. relative size of the assets divested and the stage of completion of the deal.
Our results indicate that there are statistically and economically significant positive abnormal returns to shareholders of financially distressed firms. These returns contrast with the very low (albeit still positive and significant) returns experienced by shareholders
of financially healthy firms. This result is consistent with the notion that distressed-firm shareholders benefit from the reduction in distress costs brought about by divestments. Also, we find divestor debt level has a positive and significant impact on shareholder returns, especially in the case of distressed firms. This finding is consistent with the argument that efficient monitoring by lenders leads to value-enhancing corporate decisions.
The relative size of the divestment has a positive and significant impact on the returns to healthy-firm shareholders but has no impact for distressed-firm shareholders. On the other hand, the increased degree of certainty associated with a completion announcement, as opposed to the mere statement of intention to divest, has no significant impact for either set of shareholders.
We explore the theoretical issues in Section I. We describe the sample, data, and methodology in Section II. We present and discuss our empirical results in Section III, and provide our conclusions in Section IV.
I. Theoretical Background
Empirical evidence demonstrates that, on average, divestitures lead to significant share price increases. Table 1 summarizes this evidence. There are two principal theories that seek to explain such value increase by 1) improving "fit and/or focus" (John and
Table 1. Summary Results of Voluntary Sell-Off Studies MAR = mean adjusted returns model; MM = market model; MKADJ = market-adjusted returns model; N/A= not available. Event days are relative to t = 0, the announcement day. CARs are those reported in the original studies. Announcement dates of divestment intention and completion are indicated by - and +, respectively.
Sample Size Study, Year Methodology CAR (%) Event Days Test Statistic and Period
Hearth & Zaima, 1984 MM 3.55 (-5,5) t = 3.14"** 58
(1979-81)
Rosenfeld, 1984 MAR 2.33 (-1,0) t = 4.60*** 62
(1969-81)
Alexander et al., 1984 MKADJ 0.40 (-1,0) NS 53 -0.31 NS 39
(1964-73)
Linn & Rozeff, 1984 N/A 1.45 (-1,0) t = 5.36*** 77
(1977-82)
Montgomery et al., 1984 MM 7.25 (-12 months, 12 NS 78
months) (1976-78)
Jain, 1985 MM 0.09 (0) NS 1064
(1970-78)
Klein, 1986 MM 1.12 (-2,0) t = 2.83*** 202
(1970-79)
Hearth & Zaima, 1986 MAR 1.42 (-1,0) t = 4.06*** 75
(1975-82)
Hite et al., 1987 MM 1.66 (-1,0) z = 4.08*** 55
(1963-83)
Hirschey & Zaima, 1989 MM 1.64 (-1,0) t = 4.02*** 64 2.83 t = 5.12*** 26
(1975-82)
Hite & Vetsuypens, 1989 MM 1.12 (-1,0) z = 9.12*** 468
(1973-85)
Hirschey et al., 1990 MAR 1.47 (-1,0) t = 4.36*** 75
Ofek, 1995) and 2) reducing the costs of financial distress.
However, these two theories are not mutually exclusive. Lenders can gain at the expense of shareholders if sell-off proceeds are used to pay down debt. However, the empirical evidence on the impact of paying down debt on shariholder wealth gains from sell-offs is inconclusive (Brown et al., 1994; Lang et al., 1995). For the purposes of this paper, we assume that if bankruptcy and its associated costs are avoided, both stakeholders benefit. This paper focuses explicitly on the comparative wealth experience of shareholders in financially distressed and financially healthy firms that conduct voluntary sell-offs.
A. Divestment by Financially Healthy Firms
John and Ofek (1995) examine fit and focus as the two primary motivations for asset sales. Where the divested asset has a better fit for the buyer than for the divestor, value can be created by the sell-off and the two firms can "split the difference" (Sicherman and Pettway, 1992). Where a business goes "out of focus" and begins creating negative synergy, selling it off can lead to enhanced performance of the divestor's remaining portfolio and a consequent shareholder wealth increase. John and Ofek (1995) report evidence supporting of both motivations.
B. Divestments by Financially Distressed Firms
One way to deal with financial distress is to generate sufficient cash through asset sales to meet debt obligations (John, 1993). Several studies provide empirical evidence that supports this argument (e.g. Ofek, 1993; Asquith et al., 1991; Brown et al., 1994). Such divestments allow a firm to avoid both direct and indirect financial distress costs. Direct costs cover, inter alia, legal and administrative expenses (Gilson et al., 1990; Weiss, 1990; Betker, 1995). Indirect bankruptcy costs, which are likely to be more substantial than direct costs, include the opportunity cost of suboptimal operating and investment decisions (Altman, 1984; Gilson et al., 1990). Stakeholders such as customers, suppliers, lenders, and employees may be reluctant to transact with a firm in financial distress (Cornell and Shapiro, 1987). See Chen, Weston and Altman (1995) for a recent synthesis of the theoretical literature on financial distress. There are, therefore, substantial a priori grounds for expecting a shareholder wealth gain if bankruptcy is avoided and the financially distressed firm recovers its financial health.
C. Comparative Impact of Divestments by Distressed and Healthy Firms
In the case of a healthy-firm divestor, shareholder
wealth increments should equal the net present value (NPV) of the divestment. However, with financially distressed firms, the wealth increments exceed the NPV, since the probability of eventual liquidation is lowered and the expected liquidation costs are reduced (Burgstahler et al., 1989). Thus, we expect higher returns for distressed-firm shareholders than for healthy-firm shareholders.' To allow us to focus explicitly on divestors who experience financial distress prior to sell-offs, we employ a widely used measure of bankruptcy risk, the z-score (Altman, 1968; Taffler, 1984).
The arguments stated above are tested against the following null hypotheses:
1Ho-: Sell-offs by potentially bankrupt firms do not generate significant abnormal returns when divestments are announced.
HI: There is no significant difference in market reaction between divestments by financially healthy and financially distressed firms.
Following our earlier analysis, we expect abnormal returns to sell-off by financially distressed firms to be positive and higher than those of financially healthy firms.2
D. Impact of Lender Monitoring Debt has an agency monitoring role (Jensen, 1989).
We would therefore expect that the higher the leverage, the more likely it is that divestments will be value-enhancing. Further, if debt has a significant bank lending component, its monitoring role is reinforced. Hirschey et al. (1990) argue that the presence of bank debt adds credibility to management's divestment decision by increasing the probability that net proceeds will exceed the NPV of continued ownership of the divested asset by the divestor. Significant bank debt should thus be associated with higher returns to sell-offs. Hirschey et al. find that the level of bank debt has the anticipated positive relationship with shareholder returns. We posit such monitoring is even
'Hearth and Zaima (1984) and Sicherman and Pettway (1992) investigate the relative abnormal returns to "good" and "poor" financial status divestors and report significantly higher returns to good-firm shareholders. They attribute this to greater negotiating power vis-a-vis the buyers. However, their financial status measures do not relate to bankruptcy potential. 2Any positive NPV from an asset sale by a financially distressed firm may be appropriated by lenders. If so, shareholders may experience smaller gains from the sale than when the proceeds are not used to pay down debt (Brown et al., 1994). While we do not examine how the divestment proceeds are used by our sample firms, the presumption that they are used to pay off lenders introduces a bias against observing significant positive abnormal returns for our distressed sample.
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more benign when the divestor is financially distressed and the bankruptcy event is avoided.3 The following null hypothesis is tested:
HI3: The comparative stock market reactions to divestments by financially healthy or financially distressed firms do not differ with debt level.
E. Impact of Control Variables
Earlier studies show a positive relationship between relative size of divestment and shareholder wealth increase (e.g. Klein, 1986; Afshar et al., 1992). Similarly, if the divestor announces completion of the deal (as opposed to mere intention to divest) market reaction is more positive (e.g. Hearth and Zaima, 1986; Klein, 1986; Afshar et al., 1992). In both cases, we would expect stock market response to be greater for financially distressed firms.
II. Sample and Empirical Methodology
A. Sample
Initially, we examine all firms that announced divestments inAcquisitions Monthly between January 1985 and December 1986.4 From this population we select nonfinancial firms with sell-off announcements only. Following Bi and Levy (1993), our initial observation period runs from ten days prior to divestment announcement (t=0) to ten days post- event. To avoid confounding measurement of market reaction to the divestments (Denning and Shastri, 1990), we exclude firms with overlapping announcements of other important events, such as bids or disposals that occur within the 81-day window centered on day t=0.
Our final sample consists of 142 UK manufacturing, construction, and retail companies that sold off part of their assets during the period 1985-86.5 The average
equity market capitalization of the financially distressed sample is ?52m, ranging between ?3m to ?530m. For the healthy firms, the mean market value is ?679m with a range of ?2m to ?6,717m. This latter sample has 15% of market value above ?lbn. The mean divestment size for the distressed firms is ?3.2m with a range of ?45,000 to ?21.2m. For the healthy firms, the equivalent figures have a mean of ?17.8m, and range between ?62,000 and ?686m.
The sample includes 28 firms identified as potentially bankrupt by applying a widely used UK-based z-score model (Taffler, 1984) akin to Altman (1968). Firms with a negative z-score are classified as potential failures, as their financial profiles resemble those of previously bankrupt firms.
The model, developed using linear discriminant techniques, takes the following form:
z = c+ cIx, + c2X2 c3X3 + c4X4 (1)
where x ...x4 denote the financial ratios, and Co...c4 the coefficients which are proprietary. There are two versions. The first is used to analyze listed manufacturing and construction companies and has component ratios (with Mosteller-Wallace percentage contribution measures in brackets): profit before tax/ current liabilities (53%), current assets/total liabilities (13%), current liabilities/total assets (18%), and no- credit interval (16%). The second variant is used to rate listed retail enterprises and has ratios: cash flow/ total liabilities (34%), debt/quick assets (10%), current liabilities/total assets (44%), and no-credit interval (12%).
Taffler (1995) tracks the performance of this model from its development. Overall, it has had a better than 98% success rate in classifying subsequently bankrupt companies as potentially insolvent (z<0) based on their last accounts prior to failure, and exhibits true ex ante
predictive ability in statistical terms.
3Gilson et al. (1990) provide further evidence of banks'
superior monitoring abilities in financially distressed firms in the context of private debt restructuring. 4Acquisitions Monthly records, inter alia, details of all
corporate divestments that are announced to the London Stock Exchange (LSE) by UK firms listed on the LSE, mentioned in
company press releases, or reported in the financial press. In most cases, the announcement date is the date of release of information by the divesting firm. In a few cases, however, the dates provided are those of the relevant press reports, taken as the first public indication of the sell-off event. Note that stock market access to such information may have pre- dated press publication. Where possible, dates were also cross- checked with Financial Times Mergers and Acquisitions International. 5 Event dates are not clustered in calendar time. The observations are distributed quite evenly across the sample
period with 44% of the divestments occurring in 1985 and the remainder in 1986. The following table shows the monthly distribution of divestment announcements in percentages:
Daily return information and pre-observation period equity market capitalization data were drawn from Datastream International, an on-line financial database. The debt financing ratio is taken from the MicroEXSTAT computerized financial statement database provided by Extel Financial. This ratio is defined as book value of total debt/book value of total capital employed (net capital employed plus short-term debt).6
C. Methodology Our empirical methodology is designed to measure
the impact of divestment announcements and the relationship between stock market reaction and bankruptcy risk and lender monitoring.
1. Estimation of Abnormal Returns We use the conventional mean-adjusted returns
(MAR) model (Brown and Warner, 1985; Bi and Levy, 1993) to test H01, and H02. We compare daily returns during the observation period to the mean daily returns of the pre-announcement estimation period (t= -200 to t=- 11). Abnormal returns associated with the sell- off event are represented by the excess of actual over the mean benchmark returns. The cumulative portfolio abnormal returns for any interval in the observation period are the average abnormal returns summed over that interval. The MAR model minimizes the bias in the expected returns that arises with the market model because of the small size effect (e.g., Levis, 1989; Dimson and Marsh, 1986) and the bias introduced in the share price behavior of financially distressed firms (e.g., Aharony et al., 1980; Theobald and Thomas, 1982).7
We test Ho0 by using the following test statistic based on the ratio of the MAR to the estimated standard deviation of the daily average abnormal returns during the estimation period (Brown and Warner, 1985, Equation 5):
CAR t = (2)
T 1/2AR AR
where CART is the cumulative abnormal return over T days and oAR is the standard deviation of the daily average abnormal returns.
If the abnormal returns are normal, independent, and identically distributed, the test statistic is a Student t under the null hypothesis. Given that the event dates are not clustered, we do not expect that ignoring any possible cross-sectional dependence will induce significant bias in the variance estimates (Brown and Warner, 1985). In line with the research shown in Table 1, we focus on event window days (-1,0) to allow for ambiguity in the timing of release of divestment announcements.
We test H02 using the t-statistic for the difference in cumulative average abnormal returns between the financially distressed sample, CARD, and that for the healthy sample, CARH,
CARD -CARH td= T1/2
((2ARD + A2 (31/2) d
T/2 2AR,D 2AR,H12
where 0AR,D and aAR,H are the standard deviations of the daily average abnormal returns for the financially distressed and the healthy samples, respectively, and T is the cumulation interval in days. This test is appropriate under the assumption that we are dealing with independent random samples with different variances (see Sicherman and Pettway, 1987, footnote 4, for details of this test).
2. Estimation of Impact of Lender Monitoring To test H03, the following model regresses two-day
(-1,0) abnormal returns on the debt financing ratio, the relative size of divestment, and a dummy variable for sell-off completion announcement versus an intention- only announcement. We also include in the regression interactive terms to measure the joint impact of these variables and divestor financial status. We estimate the following equation:
AR(1,o0)i = a + P1 Di + f'1D DiZi+ 2 Si+ 2 SiZ + P3 Ci S
C'3iZi"C7 Ei (4)
AR(- ,Oi is the abnormal return for firm i on days -1 and 0 where
D. is the pre-divestment debt financing ratio derived from the firm's last published accounts prior to the divestment event.
Z. is the measure of financial status equal to 1 for financially healthy (i.e. positive z-score) and 0 for financially distressed (i.e. negative z-score) firms.
Si is the relative divestment size represented by
6Due to the absence of a well-developed corporate bond market, debt financing in the UK is provided primarily by the commercial banking sector. Even short-term bank debt functions as a permanent source of loan capital. Further, our choice of book, rather than market, value of equity reflects the predominant use of the former measure in bank loan covenants. 7To explore the sensitivity of our results to potential benchmark error, we also replicate our abnormal returns analysis using the market-adjusted model (b=l) (Brown and Warner, 1985). These results are not reported here as the conclusions are similar, but are available from Lasfer on request.
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Figure 1. Cumulative Abnormal Returns for 21-day Event Period Centered on Announcement Day 0 for the Financially Distressed and Financially Healthy Samples
0.06
C,
ci a) 0.04
CO
-0
0
E -0.02
0.04
-15 -10 -5 0 5 10 15
Days Relative to Divestment Date
i Financially Distressed Financially Healthy
the ratio of sell-off size to firm i's equity market value as at the end of the calendar month immediately prior to the announcement day.
C1 is a dummy variable taking the value of one if completion is announced and zero for intention only.
C is the error term with zero mean and constant variance.
Ill. Empirical Results In this section we present the results of the tests of
our null hypotheses.
A. Abnormal Returns Around the Divestment Event
Figure 1 charts the cumulative average abnormal returns (CARs) for the 21-day event period centered on the announcement date.8 The apparent downward
drift for both samples prior to the divestment event is clearly reversed by the announcement.
Table 2 summarizes the CARs for selected observation windows for the full sample, and separately for the two healthy and distressed subsamples. The two-day (-1,0) CAR for the full sample is 0.82%, which is significant at the 0.01 level and similar in magnitude to the returns reported in earlier studies (see Table 1). For the same window, the financially distressed firm sample CAR is 2.12%, which is significant at the 0.01 level. The CAR for the financially healthy firms is 0.49%, which is significant at the 0.05 level. We therefore reject H01. The difference in two-day event period CARs of 1.63% between the two samples is statistically significant at the 0.05 level.9 Whereas the impact of
8 Five individual extreme outliers in the financially distressed sample defined as AR > 15%, for days -5, -6, +9 (2 cases) and
+10, were replaced by mean values to minimize their distorting impact on the results, given the small sample size. However, no such adjustment was required for any of the other days in the 21-day observation period, particularly days -1 and 0. 9 The results using the market-adjusted model benchmark are similar. For the financially distressed firms, the 2-day (-1,0) CAR is 1.82% (t=2.33). For the financially healthy sample it is 0.45% (t=1.71). The difference of 1.37% is significant at the 0.10 level (t=1.71).
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Table 2. Distribution of Cumulative Average Abnormal Returns (CARs) (%) of All Firms (142 firms), Financially Distressed Sample (28 firms), and Financially Healthy Sample (114 firms) over Selected Observation periods Abnormal returns are the difference between the actual returns and the mean returns derived from the estimation period. The statistics are derived according to Equations 2 and 3.
All Firms Distressed Healthy
Cumulation Interval
(T days) CAR % t CAR % t CAR % t t
-10 to 10 -0.10 -0.13 2.22 0.95 -0.42 -0.52 1.13
-2 to 0 1.27 4.25*** 1.70 1.94* 1.16 3.81*** 0.58
-1 0.24 1.38 0.91 1.80* 0.07 0.42 1.57
0 0.58 3.34*** 1.21 2.38** 0.42 2.39** 1.47
-1 to 0 0.82 3.34*** 2.12 2.96*** 0.49 1.99** 2.21
1 to 10 0.32 0.59 0.35 0.22 0.32 0.57 0.02
***Significant at the 0.01 level. **Significant at the 0.05 level. *Significant at the 0.10 level.
Table 3. Explanatory Descriptive Statistics
The debt Financing Ratio is total debt/book value of total capital employed, including short-term debt. Relative Divestment Size is the ratio of the sell-off to divestor's equity capitalization at the end of the calendar month prior to the announcement day. Completion Announcement is a dummy variable equal to 1 if the divestment announcement states completion of sell- off, 0 if only the intention to sell-off is announced. The test statistic td is for the difference in means between healthy and distressed samples. In the case of the completion variable, it is based on the test for difference in sample proportions.
All Firms Distressed Firms Healthy Firms
Variable Mean Median St. Dev. Mean Median St. Dev. Mean Median St. Dev. td
***Significant at the 0.01 level. *Significant at the 0.10 level.
the divestment event is small in the case of the financially healthy firms, in contrast it is economically material for the distressed firms. This is consistent with sell-offs representing a mechanism for restoring financial health. We must, therefore, also reject H02'10
Neither period (days t = -10 to -2) nor period (days
t = +1 to +10) generate statistically significant differences between the financially distressed and financially healthy samples. Our results differ from
10 If the event window is extended to (-2,0), Hol is still
supported, with the distressed firm sample experiencing a CAR of 1.70%. However, although this CAR still exceeds that for the healthy firms by 0.54%, this difference, as Table 2 shows, is no longer significant. A broadly similar conclusion applies when event days -1 and 0 are considered separately.
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***Significant at the 0.01 level. **Significant at the 0.05 level.
*Significant at the 0.10 level.
those of Hearth and Zaima (1984) and Sicherman and Pettway (1992), inter alia, reflecting our study's clear focus on financial distress. They emphasize the need to account explicitly for the financial condition of the divestor when evaluating market reaction to the sell- off event.
B. Impact of Explanatory Variables
Table 3 reports descriptive statistics for the explanatory variables in Equation (2). As we would expect, the distressed firms rely to a much greater extent on debt financing, with their mean debt financing ratio almost 70% higher. This difference is significant at the 0.01 level. Sell-offs by these firms are also of greater relative size, on average, than those of the healthy firms, with the difference significant at the 0.10 level. On the other hand, the two samples do not differ in terms of the relative frequency of completion versus intention-only announcements.
Table 4 presents the coefficient estimates for the regression model Equation (4). The results indicate that a significant proportion of the market reaction to sell- offs is explained by the explanatory variables (R2= 0.25). The coefficient on the debt financing ratio D, is
positive and significant at the 0.01 level. This suggests that debt obligations lead to effective monitoring of
managers, compelling them to take value-maximizing decisions. This is consistent with the arguments of Jensen (1989) and Ofek (1993). Further, the negative (and significant at the 0.10 level) coefficient on the interactive term
DAZi indicates that such monitoring is
more effective in the case of the distressed firms, as argued above. This result also highlights the incremental impact of bankruptcy risk on divestor returns over and above that of debt level and points to the danger of using debt level as a proxy for bankruptcy risk. H03 is therefore rejected.
The announcement of divestment completion (as
opposed to just the intention to divest) has no significant impact on shareholder returns for either the distressed or healthy samples. The relative size of the divestment has a significant and positive impact on abnormal returns only for the healthy group. This is indicated by the positively signed and highly significant (at the 0.01 level) coefficient on the interaction term
SZi, but a non-significant coefficient
for Si alone.
IV. Discussion and Conclusion
Our study adds to the emerging literature on how
companies resolve financial distress. In particular, we explore the use of asset sales as a strategy by potentially bankrupt firms to ameliorate their financial situation. Market reaction to divestments undertaken by financially distressed firms is contrasted with that for financially healthy companies. Overall, consistent with the generality of earlier studies, voluntary sell- off appears to be a shareholder wealth enhancing decision. However, in the UK, such wealth enhancement is predominantly driven by divestitures of financially distressed firms, while abnormal returns to healthy firms are not economically significant. The
higher returns to financially distressed firms therefore
appear to be an adjustment for reduction in financial distress costs.
Our cross-sectional regression results also show that market reaction to sell-off announcements is
positive and contingent upon lender monitoring as
proxied by the level of debt. Such monitoring is even more beneficial in the case of financially distressed firms, providing strong support for Jensen's (1989) argument that lenders play an important role in reducing agency costs.
The added certainty of completion, rather than mere stated intention to divest, has no significant impact on shareholder returns following divestment. By
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significant for the healthy, but not for the distressed, firms in influencing market reaction. These results are largely contrary to our prior expectations. They may be driven by other mediating variables not included in the regression, such as the predivestment performance of the sold-off businesses.
In addition to divesting assets, several options, such
as financial restructuring, refinancing, management changes, and mergers, are available to potentially bankrupt firms. Our results suggest that sell-off is regarded by the stock market as a viable "escape route. "
The basic conclusion of this paper is that, in the UK at least, the main benefit from divestitures comes from the resolution of financial distress. 0
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