eBusiness Weekly
Blessing Nyatanga
Introduction
Divestiture means the sale of or disposition of certain company assets or a business unit which is not performing well and disposed either through closure or sale.
An overview of divestment
As compared to other asset restructuring activities, divestitures aim at contracting firm boundaries, whereas, e.g., acquisitions are used to expand them (Bowman & Singh, 1990). Early contributions in strategic management tended to look at divestment from the viewpoint of a product life-cycle approach, and argue that divestment is one of several strategic options for “declining” industries (Davis, 1974; Harrigan, 1980).
Divestment was advocated as an appropriate route in “end game” situations characterised by high volatility and uncertainty regarding future returns.
Divestment has also been from a corporate portfolio perspective: a company can be regarded as a portfolio of assets, products, and activities, which should be continuously under review from both financial and strategic point of view (Chow and Hamilton, 1993).
The contention that poorly performing units are likely candidates for divestment, is supported in a number of studies (Duhaime and Grant, 1984; Hamilton and Chow,1993). Studies also indicate that corporate financial performance influences divestment.
For example, in their study of 208 divestments made by large New Zealand companies during 1985-90, Hamilton and Chow (1993) report that the necessity of meeting corporate liquidity requirements was among the most important objectives motivating divestment. In addition to the narrow financial considerations, which are undoubtedly important, strategic considerations also play an important role in the decision to divest.
Types of Divestiture
Asset Divestiture
In an asset divesture the parent company sell a part of its assets to another firm. DePhampilis (2010) defines an asset divestiture as the sale of a portion of a firm’s assets to an outside party, generally resulting in a cash infusion to the parent. Such assets may include a product line, subsidiary, or division.
The buying company thereby acquires majority control of the assets in question, while the divesting firm receives cash and or shares and gives up ownership and control of a part of the company’s asset (Khan & Mehta, 1996).
Spin-Off
A spin-off is the creation of an independent company through the sale or distribution of new shares of an existing business or division of a parent company. A spin-off is a type of divestiture.
The spun-off companies are expected to be worth more as independent entities than as parts of a larger business.
When a corporation spins off a business unit that has its own management structure, it sets it up as an independent company under a renamed business entity. The company that initiates the spin-off is referred to as the parent company.
A spin-off retains its assets, employees, and intellectual property from the parent company which gives it support in a number of ways, such as investing equity in the newly formed firm, and providing legal, technology, or financial services.
There are a number of reasons why a spin-off may occur.
A spin-off may be conducted by a company so it can focus its resources and better manage the division that has better long-term potential. Businesses wishing to streamline their operations often sell less productive or unrelated subsidiary businesses as spin-offs.
For example, a company might spin off one of its mature business units that is experiencing little or no growth so it can focus on a product or service with higher growth prospects.
On the other hand, if a portion of the business is headed in a different direction and has different strategic priorities from the parent company, it may be spun off so it can unlock value as an independent operation.
A company may also separate a business unit into its own entity if it has been looking for a buyer to acquire it for a while, but was unsuccessful.
For example, the offers to purchase the unit may be unattractive and the parent company might realise that it can provide more value to its shareholders by spinning off the business sector.
Impact of divestiture on firm performance
John and Ofek (1995) documented a significant improvement in the performance of the seller firm’s remaining assets in the two years following the divestment.
Lang, Poulsen and Stulz (1995) suggested that firms benefit from announcing successful sales because a successful sale means that the firm received enough money to make the sale worthwhile.
Cho and Cohen (1997) found that firms experience improved operating performance following divesting. Haynes, Thompson and Wright (2002) indicated that divestment significantly, positively and substantially improves firm profitability.
Dittmar and Shivdasani (2003) showed that changes in divisional investment are associated with decreased diversification discount.
Furthermore, Hanson and Song (2003) documented that divestitures improve firm operating performance, and this improvement possibly results from the removal of negative synergies.
This article ascertains that firms engaging in divestitures may decrease the resource misallocation and reallocate these resources to valuable segments.
In addition, divestment can relax financial constraints for the remaining segments of firms. This can make them have more opportunities to invest on net present value projects and gain performance improvement.
Blessing Nyatanga holds a Bachelor’s degree in banking and investment management from NUST.0784909184/[email protected]
