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The Economic Causes and Consequences of Corporate Divestiture

Myeong-Hyeon Cho and Mark A. Cohen
Managerial and Decision Economics
Vol. 18, No. 5 (Aug., 1997), pp. 367-374
Published by: Wiley
Stable URL: http://www.jstor.org/stable/3108098
Page Count: 8
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The Economic Causes and Consequences of Corporate Divestiture
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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.

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