Short-term stock performance

H1: Announcement of corporate divestments result in positive short-term abnormal stock returns In perfectly efficient capital markets, the announcement of corporate divestments should not affect the market value of the parent firm unless the future cash flows of the firm are expected to increase as a result of the transaction, e.g., elimination of negative synergies from low performing or non-related business units. However, H1 is consistent with previously described motives of completing divestitures. In existing empirical research, the announcement effect is broadly analysed with con-sensus of significant positive abnormal returns demonstrated on samples of transactions from both US and Europe before the turn of the millennium.

H1a: Announcement of spin-offs result in higher short-term abnormal stock returns than announce-ment of sell-offs

The review of previous empirical findings indicates higher abnormal returns on spin-off announce-ments compared to sell-off announceannounce-ments. Sell-offs involve uncertainty about how management actually intend to use the proceeds generated. This uncertainty is not present in spin-off transactions reducing the risk of divestitures motivated by managerial invectives rather than shareholder value maximization. According to Powers (2001), incentives for managers of spin-off parents are likely to be closely aligned with maximizing shareholder value, since spin-offs reduce the size of parent’s em-pire without generating additional cash for new investments (Powers, 2001). H1a is also consistent with the findings of Prezas and Simonyan (2015) demonstrating significantly higher abnormal stock returns around announcement for spin-offs compared to sell-offs.

Value drivers of short-term abnormal returns

The objective of the hypotheses described in this section is to test various underlying motives and factors impacting the value creation of corporate divestments. In this thesis, the most important fac-tors have been selected, tested, and analysed.

Corporate refocusing

Corporate refocusing is often cited as the predominantly motive for corporate divestments. Refocus-ing increase flexibility and agility of the parent firm. In addition, corporate refocusRefocus-ing eliminates po-tential dissynergies of combining unrelated assets. In addition, firms representing pure plays on spe-cific businesses and industries are often more highly valued (Miller, 1977). Therefore, parent firms announcing focus-increasing divestments are expected to realize larger short-term abnormal returns than firms announcing non-focus increasing divestments.

H1b: Industry focus increasing divestments are associated with higher short-term abnormal stock returns than non-focus increasing divestments

In previous empirical studies, the industry refocusing motive is often measured on the Standard Industry Classification (SIC) code. Focus increasing divestments are transactions where the parent and divested business unit have different SIC codes. In non-focus increasing divestments, the parent and divested business unit have the same SIC code. Several empirical studies demonstrate signifi-cantly higher short-term abnormal stock returns for cross-industry divestments including Shipper and Smith (1983), Daley, et al., (1997) and Desai and Jain (1999)¹¹ for US firms and Veld and Veld-Merkoulova (2004) and Kaiser and Stouraitis (2001) for European firms. The same results were found by Hite and Owers (1983) using official company transaction announcements instead of SIC codes to categorize focus increasing and non-focus increasing divestments.

In addition to industry refocusing, corporate divestments might be motivated by geographical refo-cusing. Activities in many different parts of the world increases organizational complexity resulting in higher monitoring and coordinating costs (Veld & Veld-Merkoulova, 2004). Management in highly geographical diversified firms risk spending too much time evaluating performance on relatively less important markets. In relation to Agency Theory, geographical diversification might be the result of risk reduction and management empire building rather than exploiting economies of scale to increase shareholder value. On the other hand, geographical refocusing might reduce economies of scale if products for different geographical markets were produced together. Thereby, geographical refocus-ing might cause relative disadvantages to competitors operatrefocus-ing internationally.

H1c: Geographical focus increasing divestments are associated with higher short-term abnormal stock returns than non-focus increasing divestments

In their study, Veld and Veld-Merkoulova (2004) demonstrated that differences in return of geograph-ical focusing and non-focusing divestments were statistgeograph-ically insignificant showing no explanatory power. The literature presents arguments for both negative and positive effects of geographical fo-cus, which are mainly case-specific considerations. However, the variable is included in this thesis to provide more evidence on the effect of geographical refocusing.

Information asymmetry

11Desai & Jain (1999) obtain the same results using a Herfindahl index and the development in number of business seg-ments to identify focus-increasing divestseg-ments.

Firms are increasingly facing a pressure from investors and security analysts to de-diversify to in-crease stock intelligibility since difficulties in valuing firms operating in different industrial sectors of-ten lead to undervaluation (Zuckerman, 2000). According to the conglomerate discount demon-strated by Berger & Ofek (1995), diversified firms characterised by low transparency and high infor-mation asymmetry between management and investors are often undervalued in capital markets. If firms with information asymmetry are undervalued, then the wealth effects of announcing a divest-ment should be positively correlated to the level of information asymmetry. Thus, firms with high in-formation asymmetry are expected to generate more value through divestitures than firms with low information asymmetry.

The level of information asymmetry is difficult to define and observe requiring proxy variables to approximate the specific level of information asymmetry for each firm. The literature does not con-clude on any measure of information asymmetry as superior. Thus, a variety of measurements are suggested including forecast errors, standard deviation of forecast errors, idiosyncratic volatility, and Tobins’s Q. We approximate the information asymmetry using idiosyncratic volatility and Tobins’s Q as proxy variables as formulated in H1d and H1e.

H1d: Parent firms with high idiosyncratic volatility realize higher short-term abnormal stock return around announcement of divestments

H1d is consistent with the study of Krishnaswami and Subramaniam (1999) using residual volatility in daily stock returns as approximation of information asymmetry. The idiosyncratic volatility re-moves all systematic uncertainty capturing firm-specific uncertainty which firm insiders and the mar-ket do not have equal information about. In this thesis, the idiosyncratic volatility deviation of the sample firms is calculated as the residual in the Market Model adjusted daily stock returns in the year preceding the announcement of the corporate divestment. Firms with high idiosyncratic asym-metry are expected to have higher information asymasym-metry about future cash flows and firm value.

H1e: Parent firms with low Tobin's Q realize higher short-term abnormal stock return around an-nouncement of divestments

Tobin’s Q is used as an alternative measure of information asymmetry. Tobin’s Q is calculated as the market value of a firm divided by the replacement value of the firm’s assets. As the replacement costs of assets are difficult to estimate, the book value of total assets is used as proxy variable. Lang and Stulz (1994) have previously demonstrated a negative relation between firm diversification and Tobin’s Q. Thus, market values of highly diversified firms with low transparency and high infor-mation asymmetry are often close to book value indicating undervaluation. Therefore, the firms with low Tobin’s Q are expected to realize higher short-term abnormal return as these firms are

under-valued. However, a low Tobin’s Q might be explained by firm-specific operational factors such as ex-pected growth rates and earning margins below industry comparables or limited future investment opportunities.

Relative size

Previous literature has demonstrated the relative size of the divested business unit to affect the shareholder value effect at announcement. The smaller the relative size of the divestiture, the smaller the difference between the value of the seller before and after the transaction, and thus the smaller the market reaction to the divestment announcement (Hearth & Zaima, 1984). The relative size effect is also related to the conglomerate discount and the effects of increased transpar-ency. Larger units increase transparency more resulting in larger value enhancements from reduc-ing the conglomerate discount. In addition, corporate divestments make the parent more attractive for takeovers, hence the larger the assets divested, the more attractive (Chemmanur & Yan, 2004).

H1f: Relatively larger divestments are associated with higher short-term abnormal stock returns than relatively smaller divestments

H1f is consistent with existing literature including Hearth and Zaima (1984) and Klein (1986) on US sell-offs and Schipper and Smith (1983), Krishnaswami and Subramaniam (1999), and Veld and Veld-Merkoulova (2004) for US and European spin-offs.

Financial quality of seller

Corporate divestments can be implemented to restructure a firm and enhance financial stability. The characteristics of the two types of divestments analysed in this thesis differentiates in one particular manner, as a sell-off brings liquid resources into the firm while a spin-off does not. Therefore, the financial strength of the divesting firm before announcement might be relevant when analysing and comparing shareholder wealth creation of sell-offs and spin-offs. The announcement of corporate di-vestitures from low quality firms with poor financial strength is more likely to be accompanied by less positive corporate news (Rosenfeld, 1984). Thus, firms with higher financial stability are expected to realize higher abnormal short-term stock returns. In this thesis, Altman Z-score is used as a proxy variable for financial strength.

H1g: Parent firms with highAltman Z-score realize higher short-term abnormal stock return around announcement of divestments

H1g is consistent with Rosenfeld (1984) demonstrating significant higher abnormal stock returns of high-quality firms announcing spin-offs and sell-offs compared to medium and low-quality firms.

Hearth and Zaima (1984) find that the stronger the financial position of the seller, the larger the positive excess stock return. In addition, Rosenfeld (1984) highlights that accounting for the parent firm’s financial strength should yield more accurate comparison between sell-offs and spin-offs.