Asset Sales: Their Role in Restructuring and Financing Firms [1st ed.] 9783030495725, 9783030495732

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SPRINGER BRIEFS IN FINANCE

Claudia Curi Maurizio Murgia

Asset Sales Their Role in Restructuring and Financing Firms

SpringerBriefs in Finance

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Claudia Curi • Maurizio Murgia

Asset Sales Their Role in Restructuring and Financing Firms

Claudia Curi Faculty of Economics and Management Free University of Bozen-Bolzano Bozen-Bolzano, Italy

Maurizio Murgia Faculty of Economics and Management Free University of Bozen-Bolzano Bozen-Bolzano, Italy

ISSN 2193-1720 ISSN 2193-1739 (electronic) SpringerBriefs in Finance ISBN 978-3-030-49572-5 ISBN 978-3-030-49573-2 (eBook) https://doi.org/10.1007/978-3-030-49573-2 © The Author(s), under exclusive licence to Springer Nature Switzerland AG 2020 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Switzerland AG. The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1 Why Do Asset Sales Matter in Corporate Restructuring and Financing? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 The Focus of This Book . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

.

1

. . .

1 4 5

2

Asset Sales: Markets and Selling Procedures . . . . . . . . . . . . . . . . . . . 2.1 Corporate Asset Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Structuring Asset-Sale Transactions . . . . . . . . . . . . . . . . . . . . . . . 2.3 Auctions and Bilateral Negotiations . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. 7 . 7 . 9 . 10 . 11

3

Asset Sales in the Theory of Finance . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Efficiency Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.1 Economic Change and Industry Shock . . . . . . . . . . . . . . . 3.1.2 Information Asymmetries . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.3 Conflicts of Interest and Agency Costs . . . . . . . . . . . . . . . 3.2 Financing Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.1 Macroeconomic Shocks . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.2 Information Asymmetries . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Asset Sales in Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.1 Loan Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.2 Fire Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . .

13 13 14 17 18 19 20 21 21 21 25 28

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Empirical Perspectives on Asset Sales . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Empirical Research on the Efficiency Theory of Asset Sales . . . . . 4.2.1 Information Asymmetries . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.2 Industry-Related Issues . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.3 Conflicts of Interest and Agency Costs . . . . . . . . . . . . . . .

. . . . . .

31 31 32 37 40 45

1

v

vi

Contents

4.3

Empirical Research on the Financing Theory of Asset Sales . . . . . 4.3.1 Information Asymmetries . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.2 Financial Constraints . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.3 Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4 Asset Sales in Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . .

52 52 55 56 58 61

5

Empirical Perspectives on Fire Asset Sales . . . . . . . . . . . . . . . . . . . . 5.1 Fire Sales in Nonfinancial Firms . . . . . . . . . . . . . . . . . . . . . . . . . 5.2 Fire Sales in Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.3 Fire Sales in Security Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . .

65 65 74 76 78

6

Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

Chapter 1

Introduction

Abstract In this chapter, we present the main themes of the book and set the boundaries for the discussion. We highlight why asset sales have been important for the restructuring and financing of firms in the past and why they will be even more crucial in the future, as technology and digital innovations alter the foundations of industries and economies. We conclude the chapter with an outline of the book’s contents and a statement of the objectives of each chapter. Keywords Asset sales · M&As · Allocative efficiency · Financing · Fire sales

1.1

Why Do Asset Sales Matter in Corporate Restructuring and Financing?

An asset sale1 can be defined as a type of sale through which a firm alters its scope, divesting a portion of its business by selling it to new owners. In this framework, the scope of a firm can be thought of as a collection of physical or financial assets over which either the entrepreneur or a delegated manager has an exclusive right of control. Asset sales thus contrast with transactions in which an entire firm passes to new ownership. The sale could be one individual asset or a portfolio of real assets (e.g., timberland, natural resources, buildings, ships, airplanes, factories, plants, machinery, equipment). Alternatively, a firm may divest a single financial asset or a portfolio/ package of them (e.g., treasury securities, bank loans, equity stakes, derivative portfolios). However, it is not uncommon for firms to dispose of complex combinations of real and financial assets—combinations that also involve human capital assets (e.g., a product division, bank branches, a trading desk, an asset management unit). Since asset sales often involve reducing the number of employees and the amount of assets held in the corporate name, such transactions are frequently referred to as “downsizing.” The sale must involve a payment, either in cash or stocks—or a 1

In this book, the terms asset sale and divestiture are used interchangeably.

© The Author(s), under exclusive licence to Springer Nature Switzerland AG 2020 C. Curi, M. Murgia, Asset Sales, SpringerBriefs in Finance, https://doi.org/10.1007/978-3-030-49573-2_1

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1 Introduction

combination of the two. Or the payment could include other financial securities. The means of payment in asset sales indicate one of the key characteristics of these transactions, as opposed, for example, to spin-offs, where a firm similarly alters its scope, but by distributing a stock dividend (of the divested unit) to a parent firm’s stockholders. The definition of asset sales adopted here also indicates that this book complements the literature on mergers and acquisitions (hereafter, M&A). This literature typically refers to the purchase or transfer of ownership of the entire, legally separated, although not necessarily independent, business organization. Restructuring firms may involve both growth and exit strategies. Consequently, as this book will emphasize, both M&A and partial-firm asset sales are two aspects of the capital asset markets related to firms: bundled (in M&A) and unbundled (in an asset sale). The markets for selling entire corporations and intercorporate partial-firm assets move together. They go hand in hand as part of firms’ strategic plans. Firms may expand in many ways, and their investment needs drive decisions about growth. A firm can invest internally, by financing research and development programs. However, direct internal investment of this sort cannot expand a manager’s empire as fast as a merger can. In fact, Jensen’s (1986) free cash flow theory argues that managers of firms with excess cash on hand are more likely to spend it on acquisitions than to pay it out in dividends, even if an acquisition has a negative net present value. Firms that wish to grow rapidly may expand externally through an M&A campaign. This strategy has been increasingly relevant in recent decades, particularly as part of firms’ global and technological expansions (Erel et al. 2012). Simultaneously, firms may downsize when faced with surplus assets or assets that no longer fit with existing or new strategic plans. Thus, they may occasionally trim and tidy up their corporate business portfolios by divesting pieces, or even shutting down some of their businesses. The strategic management literature has argued that a significant number of acquisitions, particularly diversifying ones, are later divested. That is clear evidence of failed strategies or managers correcting mistakes (Porter 1987). However, Weston (1989) describes this process differently: as part of a continuous alternation between errors and learning on the part of managers. Supporting this view, early empirical studies show that asset sales trigger a positive stock market response in terms of sellers’ share values (e.g., Alexander et al. 1984; Jain 1985; Klein 1986; Hite et al. 1987). Kaplan and Weisbach (1992) have shown in a careful study that no more than one-third of divested acquisitions should be classified as unsuccessful. In other words, about two-thirds of observed asset sales of previous acquisitions are clear executions of a firm’s strategic reorganization plans: the acquirer typically sells an asset or a business that it has improved, or that it once had synergies with but no longer does. Kaplan and Weisbach’s evidence is consistent with the analysis of John and Ofek (1995), who find that the typical divested division is performing as well as the industry at the time of the divestiture. Lang et al. (1995) have shown that stock market gains from asset sales are more positive when firms pay out the proceeds instead of reinvesting within the firm. Maksimovic and Phillips (2001) report that the

1.1 Why Do Asset Sales Matter in Corporate Restructuring and Financing?

3

market for corporate assets is equally split between M&A transactions and partialfirm asset sales. Warusawitharana (2008) reports that from 1985 to 2004, the US corporate asset market led to a net gain of $162 billion for shareholders in participating firms. These studies indicate that transacting corporate assets improves the allocative efficiency of capital in the economy. The studies contrast sharply with the more inconclusive evidence about the economic benefits of M&A transactions, particularly outside the period of hostile takeovers of the 1980s (see Jensen and Ruback 1983; Ravenscraft and Scherer 1987; Andrade et al. 2001; Betton et al. 2008; and Eckbo 2014 for surveys of the enormous literature on M&As). Asset-sale proceeds could be relevant when firms need to raise capital, even though they are not usually included in traditional capital-structure theories, such as Myers’s (1984) pecking order theory. In practice, asset sales as a source of financing seem to be as important as the more traditional debt and equity channels (Edmans and Mann 2019). In fact, Eckbo and Kisser (2018) find that illiquid asset sales contribute significantly to finance investments in US companies. Furthermore, a survey of 1050 Chief Financial Officers in the USA, Europe, and Asia conducted in Campello et al. (2010) revealed that 70% of financially constrained firms were able to raise funds during the 2008 financial crisis by increasing divestitures. So far, our focus has been on “voluntary asset sales,” which are by far the most common. The initial theoretical interest in the field started from the sellers’ perspective, since these transactions are thought to be mostly initiated by sellers. When divestiture decisions are motivated by a need to raise capital, theoretical models have assumed that firms are in a condition of financial distress and that there are similar financial constraints across the whole economic sector. If such dire financial conditions are shared at the industry level, the corporate asset-sale market may require the entry of industry outsiders to buy assets. However, although such industry outsiders can provide liquidity to the corporate asset market, they do not have the knowledge and competence needed to manage assets, and informational frictions cause divestitures to be executed at discounted prices. Equilibrium in asset-sale markets requires an efficient balance between industry buyers who will pay fair prices and restructure assets with a view to their best use, on the one hand, and external industry acquirers who provide liquidity but at discounted prices, on the other hand. An asset sale under conditions of broad financial duress is called a “fire” asset sale. In this case, the asset sale is forced, in the sense that the seller cannot pay creditors without selling assets. The price is dislocated because the highest potential bidders are typically involved in a similar activity as the seller, and, hence, because they themselves are already indebted, they cannot borrow more to buy the asset. If assets are bought by industry outsiders or nonspecialists, they are only willing to buy at very low valuations. Assets sold in fire sales can trade at prices far below their value in best-use scenarios, causing severe losses to sellers. A fire sale might involve generic goods, such as airplanes or financial securities. In addition to voluntary asset sales and fire sales, two other special classes of asset sales are possible: “involuntary” sales and privatizations. Involuntary asset sales may occur when, for example, antitrust and market regulators will only approve mergers if companies divest divisions or entire business segments, thereby reducing market

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1 Introduction

power that may be the result of excessive sector concentration. Privatizations, meanwhile, are government-sponsored programs to sell publicly controlled firms and assets. Privatization occurs mostly as the result of political pressures, either because of political movements to complete the transition to a market economy or because of government budget constraints. In this book, we will focus on voluntary asset sales and the fire sales, because those cases better fit with the main research questions we address. There is a rich empirical literature on asset sales, developed in research fields as diverse as industrial economics, finance, and strategic management. This book draws on this literature in order to interpret interesting stylized facts in light of key theoretical models. However, because the subject is quite extensive, with many important features that cannot be covered in a single study, the present book focuses primarily on developments in the corporate finance literature. Where appropriate, we also suggest other promising avenues for research on asset sales.

1.2

The Focus of This Book

This book’s main goal is to present a critical review of scholarly debates on asset sales. In each section of this book, we emphasize the key research questions that have driven this area of finance and how they have evolved. Where applicable, we also relate these questions to policy issues. Arguably, the literature on asset sales can be distilled down into the following two key research questions: (a) Do asset sales contribute to efficient asset management at the firm and industry level? and (b) Are asset sales an efficient capital-raising mechanism, particularly for firms with financial constraints? With the book as a whole addressing these questions, the concluding section proposes new ways of analyzing divestitures transactions, which we characterize as one element of a larger, continually evolving corporate finance ecosystem. Given the technological and digital developments that are disrupting entire sectors and dividing winners and losers across industries and countries, how will firms undertake investment and divestment decisions? Or, in the terms afforded by a different narrative, in a new world characterized by freer, richer flows of information, with more efficient financial arrangements and plenty of available external capital, how are (sometimes simultaneous) investment and divestment decisions going to be affected? The rest of the book is organized as follows. Chapter 2 describes how asset-sale transactions are structured in the real world. Chapter 3 reviews the theory of asset sales. Chapter 4 presents empirical research on asset sales and summarizes the main findings of this literature. Chapter 5 presents the empirical findings of studies on fire asset sales. Chapter 6 concludes and suggests directions for future research.

References

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References Alexander GJ, Benson PG, Kampmeyer JM (1984) Investigating the valuation effects of announcements of voluntary corporate selloffs. J Financ 39(2):503–517 Andrade G, Mitchell M, Stafford E (2001) New evidence and perspectives on mergers. J Econ Perspect 15(2):103–120 Betton S, Eckbo BE, Thorburn KS (2008) Corporate takeovers. In: Eckbo E (ed) Handbook of corporate finance, vol 2. Elsevier/North-Holland, Amsterdam, pp 291–430 Campello M, Graham JR, Harvey CR (2010) The real effects of financial constraints: evidence from a financial crisis. J Financ Econ 97(3):470–487 Eckbo BE (2014) Corporate takeovers and economic efficiency. Annu Rev Financ Econ 6(1):51–74 Eckbo BE, Kisser M (2018) Tradeoff theory and leverage dynamics of high-frequency debt issuers. Tuck School of Business Working Paper 2234435 Edmans A, Mann W (2019) Financing through asset sales. Manag Sci 65(7):3043–3060 Erel I, Liao RC, Weisbach MS (2012) Determinants of cross-border mergers and acquisitions. J Financ 67(3):1045–1082 Hite GL, Owers JE, Rogers RC (1987) The market for interfirm asset sales: partial sell-offs and total liquidations. J Financ Econ 18(2):229–252 Jain PC (1985) The effect of voluntary sell-off announcements on shareholder wealth. J Financ 40 (1):209–224 Jensen MC (1986) Agency cost of free cash flow, corporate finance, and takeovers. Am Econ Rev 76(2):323–329 Jensen MC, Ruback RS (1983) The market for corporate control: the scientific evidence. J Financ Econ 11(1–4):5–50 John K, Ofek E (1995) Asset sales and increase in focus. J Financ Econ 37(1):105–126 Kaplan SN, Weisbach MS (1992) The success of acquisitions: evidence from divestitures. J Financ 47(1):107–138 Klein A (1986) The timing and substance of divestiture announcements: individual, simultaneous and cumulative effects. J Financ 41(3):685–696 Lang L, Poulsen A, Stulz R (1995) Asset sales, firm performance, and the agency costs of managerial discretion. J Financ Econ 37(1):3–37 Maksimovic V, Phillips G (2001) The market for corporate assets: who engages in mergers and asset sales and are there efficiency gains? J Financ 56(6):2019–2065 Myers SC (1984) The capital structure puzzle. J Financ 39(3):574–592 Porter ME (1987) From competitive advantage to corporate strategy. Harv Bus Rev 65(3):43–59 Ravenscraft DJ, Scherer FM (1987) Mergers, sell-offs, and economic efficiency. Brookings Institution Press, Washington, DC Warusawitharana M (2008) Corporate asset purchases and sales: theory and evidence. J Financ Econ 87(2):471–497 Weston JF (1989) Divestitures: mistakes or learning. J Appl Corp Financ 2(2):68–76

Chapter 2

Asset Sales: Markets and Selling Procedures

Abstract How and where are corporate assets traded? In this chapter, we describe how corporate asset markets work and how a generic asset transaction is designed and structured. Keywords Asset sales · Bilateral negotiations · Business judgment · Contract law · Corporate asset markets · Liquidity · Rule auctions · Selling plan

2.1

Corporate Asset Markets

The market for corporate assets is similar to other markets: a transaction occurs if a buyer and seller match. However, there is no organized market for all types of assets where they can be traded. A firm that wants to dispose of an asset has to search for a buyer. If the market for the asset is liquid, buyers are easy to find, and, therefore, a firm can sell the asset at a price close to the present value of its cash flows. If the market for the asset is not liquid, the selling firm has to offer a liquidity discount to attract a buyer in order to sell the asset (Schlingemann et al. 2002). Attempts to sell an asset in an illiquid market can thus yield a price below the firm’s reservation price, with the result that no sale takes place (Akerlof 1970; Shleifer and Vishny 1992). There are cases of organized markets where businesses trade partial-firm assets. The creation of organized exchanges to trade real corporate assets is promoted, as the theory of markets predicts, by factors such as standardization, fungibility, industry regulation, and demand depth.1 Furthermore, advances in technology and the potential of new digital platforms may foster the opening of such specialized asset markets. That development will lead to more efficient sale contracts, improving liquidity and the execution of corporate asset transactions (Varian 2010). Absent a specialized market for corporate assets, however, a sale transaction must start with a

1 See, for example, www.aeromarkt.net for trading used aircraft, or www.genoalogisticservices.com for negotiating used containers. See also Pulvino (1998) for a description of the development of and active participants in the commercial aircraft market.

© The Author(s), under exclusive licence to Springer Nature Switzerland AG 2020 C. Curi, M. Murgia, Asset Sales, SpringerBriefs in Finance, https://doi.org/10.1007/978-3-030-49573-2_2

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Table 2.1 Seller advantages and disadvantages Buyer type Strategic

Financial

Seller perspective Advantages Buyers pay higher price and premium because buyer expects benefits and synergies Seller’s incumbent management will/could continue to manage asset

Disadvantages Acquired assets will be integrated with existing operations Buyer will pay less because buyer cannot manage asset and fears overpaying

search for buyers by sellers or for sellers by buyers. This search process is typically initiated by the seller (or a delegated agent), who either seeks a buyer or offers the asset for sale to an identified buyer. Alternatively, the process may start by a prospective buyer approaching the seller. Asset sales may attract buyers of different types, whether strategic (e.g., operating companies, sellers’ competitors, firms in the same industry although not rivals) or financial (e.g., private equity funds, hedge funds, industry outsiders). Likewise, buyers may be public or private and domestic or foreign. Bidders in cases of asset liquidation, bankruptcy, or privatization auctions may include incumbent management. As the literature on asset sales has pointed out, the variables of bidder type, selling mechanism, deal characteristics (value and premium/discount), and information frictions affect economic outcomes in asset-sale transactions (as an example, see the evidence presented in Fidrmuc et al. 2012). In Table 2.1, we summarize the advantages and disadvantages, from the seller’s perspective, of negotiating/completing an asset-sale deal with various types of buyers. This picture is enriched by the empirical evidence about stock market reactions as well as the operating performance of different buyer/seller combinations (see Chap. 4). An important characteristic of any market is liquidity (Keynes 1936). A liquid market for relatively liquid financial assets is a key determinant of sales prices and execution efficiency (Black 1971), but it is probably an even more important element when firms are negotiating transactions of intercorporate assets that are illiquid (see discussion in Schlingemann et al. 2002). If the interfirm asset market is liquid, buyers are easy to find, and clearing prices will be close to their fair value. When the market is illiquid, one important economic consequence is that observed transaction prices will be below the seller’s reservation price, and asset sales either will not take place or assets will be bought at a discount by financially robust acquirers (i.e., through fire sales involving industry nonexperts), who will not, however, use them efficiently (Shleifer and Vishny 1992). Earlier literature on asset sales centered on the key role and initiative undertaken by sellers in starting and completing divestitures transactions. Furthermore, an implicit assumption of the early literature in finance is that the seller is better informed about the asset value than the buyer is (see, e.g., Leland and Pyle 1977; Stiglitz and Weiss 1981; Myers and Majluf 1984).

2.2 Structuring Asset-Sale Transactions

9

The more recent legal and institutional characteristics of asset-sale markets around the world reveal a different picture. Both buyer and seller have active roles in structuring and influencing the contracting of the sale, and potential buyers could be better informed about the seller’s asset value than the seller is. For example, a strategic acquirer such as an experienced venture capitalist may be better than the founder at evaluating the future prospects of an entrepreneurial firm’s business plan.

2.2

Structuring Asset-Sale Transactions

Planning and preparing an individual sale or even a full-blown divestiture program can be challenging for any organization. Although M&As and divestitures share a similar transaction format and typically have a common purpose—namely, to enhance enterprise and shareholder value—there are important differences between the two types of transactions. Asset sales have greater downside risks for the seller and present unique operational challenges to the sale team. For example, a divestiture program may require establishing an asset-sale team. That involves a complex organizational commitment, which may clash with other efforts within the organization to market and get the best deals for identified assets. From this organizational perspective, asset-sale transactions are strategic (real) options that could be even more challenging to evaluate and exercise than a growth-oriented M&A campaign (Damaraju et al. 2015). Depending on security market regulations (frequently required for public firms), or statutory/law requirements (for both public and private firms), very often the divestiture plan needs board approval and sometimes shareholder approval. If divestiture entails a major restructuring of company business, it is not unusual to call a stockholders’ meeting to consider the transaction.2 Assuming controlling shareholders and the managers of the divesting company have decided on the appropriate transaction among various alternatives and considered the valuation, legal, tax, and governance issues involved, a divestiture plan must be formulated. A selling plan can be reactive or proactive.3 A reactive selling plan is used in cases where the buyer first approaches the seller, whereas a proactive selling plan applies to cases where the seller initiates the process. When a buyer moves first, by extending a proposal to buy an asset, the seller must decide whether to accept the bid because it is sufficiently attractive or to investigate other sale options. In the latter 2 In many jurisdictions, asset sales must be preliminarily evaluated by independent directors before being submitted for stockholders’ approval. Such transactions are subject to regulations for so-called related party transactions (RPTS), because they could result in opportunistic sales if not the outright tunneling of controlling shareholders. For an extensive discussion of the legal aspects of RPTS across international markets, see Enriques and Tröger (2019). 3 In this part, we draw extensively on the discussion of the divestiture selling process presented by DePamphilis (2019, Chap. 16, pages 445–450).

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case, the seller moves—de facto—to a proactive approach. In contrast, when the seller starts the sale process, the seller must decide whether to pursue a public or a private transaction. As mentioned previously, however, this process often involves delegating an investment bank, which typically helps in identifying a larger pool of potential buyers. Overall, there are three key factors that distinguish asset sales from mergers (Hege et al. 2009). First, corporate law mandates that in a merger, target shareholders have irrevocable voting and appraisal rights. Merger models reflect this fact by assuming that the final stage of the game entails a take-it-or-leave-it offer from the acquirer to the target. In contrast, an asset sale is governed by contract law and the business judgment rule, which limits disclosure and obviates shareholder participation, giving seller and buyer managers broad legal discretion to privately develop a transaction structure. Second, mergers are generally buyer-initiated, while asset sales are generally seller-initiated. Third, the sequential nature of entry into merger bidding is conducive to a preemptive bid to deter entry by other potential bidders, and thereby limit competition (Fishman 1989). In contrast, sellers of assets foster competitive and coetaneous bidding via an auction-like process, followed by private negotiations between a seller and a selected buyer.

2.3

Auctions and Bilateral Negotiations

When a seller decides on a public transaction, the process consists of a competitive auction that is followed by bilateral negotiations. As emphasized by Boone and Mulherin (2007) in the context of selling firms, the public and visible activity which surrounds the M&A market is often the tip of the iceberg. The asset-sale market works similarly, and before a major transaction is announced, a lengthy negotiation between different counterparties will have already taken place prior to the announcement of an asset sale. Very often, the starting point is to identify possible buyer(s) and then market the asset to them. Next, a confidential memorandum is drafted by the seller and the seller’s advisors; this memo typically contains relevant and indeed proprietary information to interested buyers. The memorandum must be signed by all involved counterparties to ensure its confidential agreement status. In fact, obtaining all the relevant signatures is an important step in the selling process, because if a sale does not take place, it may involve a significant cost to the selling firm. In this case, the cost is the sensitive information that is disclosed and revealed to rival firms, which they may use to gain a competitive advantage. When a private sale takes place, bidders are asked to sign a “standstill agreement,” which often requires them not to make unsolicited bids and instead submit a preliminary indication of interest with a range of offer prices. The seller and the seller’s advisors rank the indications of interest according to different criteria (bid size, method of payment, ability to finance the acquisition and easily complete the transaction, etc.). A short list of potential buyers is then selected, and candidate

References

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Proceed to negotiated settlement

Reactive sale

Public sale or auction Pursue alternative bidders Private “one-onone” or private sale

Potential seller

Public sale or auction

Proactive sale Private “one-onone” or private sale

Fig. 2.1 Typical structured asset sale (source: DePhamphilis 2019)

buyers are asked to submit a legally binding best and final offer. It is at this stage of the selling process that the seller may decide either to initiate an auction involving the most attractive bids or to negotiate directly a sale contract with a single acquirer. The selling process is shown in Fig. 2.1.

References Akerlof G (1970) The market for lemons: quality, uncertainty and the market mechanism. Q J Econ 84(3):488–500 Black F (1971) Toward a fully automated stock exchange, Part I. Financ Anal J 27(4):28–35 Boone AL, Mulherin JH (2007) How are firms sold? J Financ 62(2):847–875 Damaraju NL, Barney JB, Makhija AK (2015) Real options in divestment alternatives. Strateg Manag J 36(5):728–744 DePamphilis D (2019) Mergers, acquisitions, and other restructuring activities: an integrated approach to process, tools, cases, and solutions. Academic Press Enriques L, Tröger TH (2019) The law and finance of related party transactions. Cambridge University Press Fidrmuc JP, Roosenboom P, Paap R, Teunissen T (2012) One size does not fit all: selling firms to private equity versus strategic acquirers. J Corp Finan 18(4):828–848 Fishman MJ (1989) Preemptive bidding and the role of the medium of exchange in acquisitions. J Financ 44(1):41–57 Hege U, Lovo S, Slovin MB, Sushka ME (2009) Equity and cash in intercorporate asset sales: theory and evidence. Rev Financ Stud 22(2):681–714 Keynes JM (1936) The general theory of employment interest and money. Macmillan, London

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Leland HE, Pyle DH (1977) Informational asymmetries, financial structure, and financial intermediation. J Financ 32(2):371–387 Myers SC, Majluf NS (1984) Corporate financing and investment decisions when firms have information that investors do not have. J Financ Econ 13(2):187–221 Pulvino TC (1998) Do asset fire sales exist? An empirical investigation of commercial aircraft transactions. J Financ 53(3):939–978 Schlingemann FP, Stulz RM, Walkling RA (2002) Divestitures and the liquidity of the market for corporate assets. J Financ Econ 64(1):117–144 Shleifer A, Vishny RW (1992) Liquidation values and debt capacity: a market equilibrium approach. J Financ 47(4):1343–1366 Stiglitz JE, Weiss A (1981) Credit rationing in markets with imperfect information. Am Econ Rev 71(3):393–410 Varian HR (2010) Computer mediated transactions. Am Econ Rev 100(2):1–10

Chapter 3

Asset Sales in the Theory of Finance

Abstract Theoretical models of asset sales view those transactions either as a means to improve firm asset efficiency or as a means to raise capital. Divestiture decision models assume that divestiture is motivated by an attempt to restructure firms’ asset mix and business combinations, with most of the literature in this area focusing on exogenous factors such as macroeconomic and business cycle volatility, industry shocks driven by technology transformation, and regulatory changes. Asset-sale theory, paralleling the theory of corporate mergers and acquisitions, has directed its attention to predict “why” sales take place, “when” they will occur, and “who will sell what to whom.” In this chapter, we provide an overview of the theoretical frameworks for studying asset sales that have emerged from the research in this area. Keywords Asset sale · Business reallocation · Capital structure · Corporate restructuring · Divestiture · Fire sales · Financing asset sales · Financial distress · Industry transformation

3.1

Efficiency Theory

Efficiency-based models originated in industrial organization theory, which encompasses both the transaction-cost-economics approach (Coase 1937; Williamson 1975; Klein et al. 1978) and the property-rights approach (Grossman and Hart 1986; Hart and Moore 1990). Essentially, according to this theory, asset sales originate in a firm’s scale strategies, which result in moving assets from low-productivity uses to higher-productivity uses. Given that firms differ in their ability to exploit market opportunities, competitive markets should allocate assets to firms that manage them more efficiently. Thus, if an asset happens to be part of an unsuitable firm, or if it is in the right organization but at an inappropriate stage of the firm’s life cycle, market forces should work to facilitate the transfer of ownership and control to a more efficient organization. In the end, capital reallocations across firms reflect both capital productivity and differences between the seller and the acquirer (Tirole 2006). © The Author(s), under exclusive licence to Springer Nature Switzerland AG 2020 C. Curi, M. Murgia, Asset Sales, SpringerBriefs in Finance, https://doi.org/10.1007/978-3-030-49573-2_3

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Typically, divestitures are undertaken by firms operating in several, often different, lines of business—i.e., conglomerates. When the manager of a complex firm such as a large conglomerate observes negative synergies arising through a combination of divisions and diverse assets, she may consider a breakup transaction to be necessary or desirable. Furthermore, a firm’s internal organization has a significant effect on the probability that an asset will be sold. Breaking up, as indicated previously, might be implemented through alternative types of transactions, such as asset sales vs. spin-offs. Although these transactions differ, they are both motivated by the desire to reduce inefficiencies and costs associated with keeping the company’s assets together. Both types of transactions are often implemented by “focusing” firms, or firms in the process of reducing their business segments either to enhance efficiency or to raise funds. In what follows, we review proposed theoretical models that situate asset sales within the broader context of efficiency enhancement plans. What specifically motivates the asset-sale decision could be found in frictions inside the firm or outside, in products, and capital markets. A first key determinant of the decision to sell an asset is a demand shock, either because of business cycle or a specific industry or technology transformation. Either way, a shock of this sort could have an impact at the industry level, triggering a cascade of asset sales. A further area of friction considered in modeling divestiture decision is asymmetric information possessed by sellers vs. buyers about an asset’s net present value, which will have consequences for efficient pricing and liquidity in the intercorporate asset market. A third source of friction that could affect divestiture decisions involves agency conflicts between insiders and outsiders involved in asset sales. In some theoretical models, managers sell assets because they fear losing their jobs; in others, they are reluctant to dispose of assets, as that will reveal the mistakes they made in acquiring them. Agencymotivated sell-offs will happen either because internal corporate governance (i.e., boards) forces managers to act, or because external mechanisms (i.e., the takeover market) will lead to the replacement of inefficient managers.

3.1.1

Economic Change and Industry Shock

Macroeconomic cycles and industry shocks contribute extensively to the restructuring of firms’ asset mix and business combinations. When a macroeconomic shock hits, its effects spread to many economic sectors, and their level of individual cyclicality will affect the size of the capital reallocations they trigger. When a specific industry shock happens because of technological innovation, change in input costs, or deregulation, factors such as product market competition and financial leverage will have a prominent role in deciding which asset to dispose of and also how to price it. Shleifer and Vishny (1992) built a leverage decision model for situations where an industry- or economic-wide shock forces companies to liquidate assets. Under this scenario, a firm faces credit constraints and sells off assets to service debt.

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However, firms from the same industry (i.e., the selling firm’s competitors) suffer from the same shock; that is, they face credit constraints that prevent them from buying assets at a fundamental price.1 Whether because of financial or regulatory constraints, asset sales under these conditions involve industry outsiders, who may have less information about and less capability of managing an industry’s specialized assets. The degree of asset redeployability increases its liquidity that is crucial for selling the asset at the highest price among outside buyers and affects the firm’s debt capacity. Thus, market equilibrium is reached when there is an optimal balance between industry buyers and outsider buyers; between corporate assets that are properly evaluated (by industry rivals) and assets that are underevaluated (by outsiders); and between acquired assets that are well-managed (by industry rivals) and acquired assets that are badly managed (by outsiders). When specialized buyers of an asset received correlated shocks to their ability to borrow, fire sales occur. Two critical conditions should hold for a fire sale. First, the sale is a forced sale. Second, the natural (industry) buyers of the assets are also in distress, which makes it difficult for them to access credit. The obvious consequences of fire sales are (a) the asset is sold at a discount relative to its fundamental value; (b) the buyer is an outsider with respect to the industry; and (c) the price of the asset recovers, moving toward its fundamental value, after the sale. Under the Shleifer and Vishny’s (1992) fire sale scenario, industry specialists cannot repay creditors without selling assets, and the ultimate effect will be a cascade of similar “forced” asset sales bought by nonspecialists at dislocated prices. Extensions of Shleifer and Vishny’s framework can be found in Brown et al. (2006) and more recently in Salgado et al. (2017). These more recent models share the assumption of financial distress in the industry, but they differ in how they describe asset sellers’ implementations of their decisions and attempts to avoid costly fire sales. In Brown et al. (2006), asset sales will happen with outsiders who are either more efficient at managing the asset or have sufficient wealth to compensate for management inefficiencies. In Salgado et al.’s (2017) game theory model, firms make specialized investments and strategically compete on product markets as well as with their financial structure. In the competitive equilibrium, firms face the following trade-off. On one side, they initiate an early search of buyers to increase the likelihood of redeploying assets at a higher price before the industry shock hits. This helps increase their financial flexibility and avoid costly fire sales. These actions will promote early exit and industry transformation. On the other side of the strategic game, a firm, rather than initiating the early search of potential buyers, instead takes no action, in order to gain indirectly from the increased market concentration that results from another firm’s exit. Industry characteristics drive the resulting equilibrium. If firms operate in a highly specialized industry, asset sales necessarily will be directed to liquidity-endowed

Moreover, even when industry buyers have financial slack, or can raise funds to buy competitors’ assets, there could be antitrust and other government regulations that prevent them from purchasing the liquidated assets of competitors.

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outsiders, which will put them to alternative uses. Firms in good financial health make less effort to redeploy assets once the expected profit from continuing operations in the product market increases. These firms would never find it optimal to initiate an asset-sale campaign. In the end, this model predicts that asset liquidations will be more frequent in specialized industries, whereas in industries where gains from market concentration are larger, the cost of financial distress associated with fire sales will be higher, predicting fewer divestitures. The model also has implications for how firms design their capital structure. Because financial distress is one obvious cost of higher leverage, firms operating in industries with significant rents arising from market concentration will select ex ante a lower leverage. Several other theoretical models of asset-sale decisions have been formulated that focus more on industry and technology shocks than on the financial distress highlighted in Shleifer and Vishny’s (1992) capstone model. Maksimovic and Phillips (2002) develop a neoclassical model based on industry competition where firms manage industry specialized assets efficiently. Setting aside asymmetric information and agency costs, the decision to sell assets is made (1) when the economy is undergoing positive demand shocks; (2) when the assets are less productive than their industry benchmarks; (3) when the selling division is less productive; and (4) when the selling firm has more productive divisions in other industries. These shocks alter the value of the assets, affect growth rates of the firm’s line of business, and create incentives to transfer some assets to more productive uses. Sales will thus concentrate in less productive divisions. Warusawitharana (2008) and Yang (2008) also propose neoclassical theoretical models that rely on industry competition and productivity shocks, respectively, to explain asset sales. Warusawitharana (2008) predicts asset sales using the variables of profitability and firm size. Yang’s (2008) study is the first to investigate asset sales in a dynamic framework with equilibrium asset prices and a distribution of heterogeneous firms. The dynamic setting allows Yang to model how firms take decisions over time, and the equilibrium framework makes it possible to link firm decisions with aggregate industry activities. Her new evidence suggests how dynamic properties of productivity shocks may affect asset purchases and sales. While Shleifer and Vishny (1992) demonstrate that, in recessions, existing assets are traded at a discount due to liquidity constraints, Yang (2008) shows that existing capital can be traded either at a discount or at a premium compared to the price of new investments, even without liquidity constraints. Decisions on asset purchases and sales are not made in isolation. Rather, a firm makes decisions considering its own investment needs as well as the investment needs of all other firms in the industry. New investments are made when positive aggregate shocks raise the average productivity level in the industry, while existing assets are traded when firms’ relative positions change due to firm-specific productivity shocks. Eisfeldt and Rampini (2006) develop a quantitative dynamic model to study reallocations of existing capital over business cycles. Their model studies asset sales at the macro level and establishes two important results. First, asset reallocations increase during expansionary periods (i.e., in the procyclical phase), whereas the benefits of restructuring activities accrue in recessions (i.e., in the

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countercyclical phase). Eisfeldt and Rampini (2006) document asset sales’ procyclicality with reference to US business cycles. In a sample covering the fourdecade period 1965–2000, they find a highly significant correlation index (0.58) between the cyclical component of corporate capital reallocation in public firms and GDP. Second, the highly procyclical nature of asset reallocations stands in stark contrast to the cyclical properties of the benefits derived from capital reallocation, which can be computed using measures of the dispersion of capital productivity. These facts can be reconciled insofar as capital is less liquid in recessions, affecting the volume and liquidity of transactions in asset markets. Eisfeldt and Rampini (2006) suggest that various frictions during business cycles could generate these stylized results, including the frictions caused by informational asymmetries and agency costs.

3.1.2

Information Asymmetries

Conglomerate firms that operate in a diversified range of economic sectors are often prone to costly information asymmetries between outside capital providers and insiders (stockholders and managers), making those firms’ assets more difficult to evaluate by capital markets. When conglomerates announce major divestitures, undervaluation is often mentioned as one of the major reasons they are splitting or selling assets—in order to restore for investors a fair assessment of remaining assets. Nanda and Narayanan (1999) propose a model based on the cost of diversifying in several lines of business that arises because of asymmetric information between capital markets and management. External investors cannot clearly observe cash flows split within a conglomerate firm, so they will rationally update the overall quality of the firm as if each division’s performance were industry average. This model implies that the market will undervalue the successful division and overvalue the poorly performing division, leading to the overall discounting of the conglomerate. Because managers know which division has more or less informative cash flows, they are aware if the firm is over- or undervalued. The model’s empirical prediction is that to fund investment opportunities, the overvalued firm will always choose to float new equity, whereas the undervalued firm might choose instead to sell assets. In the latter case, the firm will divest the underperforming division (since it is overvalued) in order to lower the cost of capital for the undervalued division. In short, Nanda and Narayanan (1999) argue that informational frictions are more relevant in divestiture decisions than agency-based costs (see Sect. 3.1.3). Hege et al. (2009) model a different consequence of information asymmetry in the corporate asset-sale market. Their model’s central prediction is that when a seller has unfavorable information about a division’s performance, the seller is more likely to accept cash consideration. On the contrary, when the seller has positive information about the asset prospects, the seller proposes a take-it-or-leave-it counteroffer that involves buyer equity as the main means of payment. This model treats asset sales as a partial merger, consequently challenging the hypothesis that equity-based

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transactions generate less favorable share price effects, as proposed in models of equity-based mergers (see, e.g., Travlos 1987; Servaes 1991). That hypothesis about mergers contrasts with empirical results for asset sales (Slovin et al. 2005). Hege et al.’s (2009) model is built from a two-sided asymmetric information structure. Sellers of assets hold important private information about the intrinsic quality of the asset, both concerning cash flow prospects and concerning contingent liabilities. They initiate the transaction through competitive bidding, via an auctionlike process used to screen buyers. Each potential buyer may also have private information about the value the asset can generate if it is conjoined with the buyer’s existing assets. In a second stage, the seller initiates exclusive bilateral negotiations with the buyer offering the highest bid, making a take-it-or-leave-it counteroffer encompassing buyer equity. Thus, asset-sale transactions can conclude via the seller’s counteroffer, which is a peculiarity of asset sales compared to mergers. The seller’s counteroffer is a signal-of-quality mechanism that cannot be imitated by sellers with low-value assets. Overall, Hege et al. (2009) predict that cash asset sales generate small gains, which accrue mainly to the seller. Differently, equitybased asset sales will generate greater gains in combined wealth that are shared by buyer and seller, with this increase in wealth being a reward for the two counterparties’ information rent. A key result of the model is that the intercorporate asset-sale market may find an equilibrium where selling firms establish contractual arrangements to obtain transactions that are efficient from an informational point of view.

3.1.3

Conflicts of Interest and Agency Costs

Divestitures require managers of selling firms to deal with managers working for the buyer. These transactions, as described in Chap. 2, are different from mergers and acquisitions, where managers of the acquiring company are effectively dealing with owners of the target firm. Obviously, the asset involved in the transaction is differently valued by buyer vs. seller. Taking into account this crucial aspect of asset sales, a substantial part of the specialized literature has advocated that divestiture decisions could be influenced by conflicts of interest. Most such conflicts arise between the management teams of the two involved firms, but conflicts could also involve one firm’s owners and the other firm’s stakeholders. An early attempt to model the dynamics of asset sales in a conflict-of-interest setup is Meyer et al. (1992). In this model, which they named as an influence cost theory, a key assumption is that asset sales are undertaken because managers are afraid of losing their jobs. Thus, asset sales should be observed more frequently in firms and industries under significant restructuring threats because of exogenous shifts in the technological or business environment. These changes trigger firm/industry layoffs, which include firm- or industry-specialized managerial positions. Under more job risk, managers will have incentives to engage in more efficient divestitures. However, an alternative model was proposed by Boot (1992),

3.2 Financing Theory

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who argues that managers are reluctant to divest assets, since doing so could be seen as an admission of inappropriate prior investment choices. Therefore, alternative governance mechanisms are required to force managers to sell unproductive assets. The mechanism in question could be an internal mechanism, such as the board of directors expected to act in the best interests of shareholders, or an external mechanism, such as a raider or an activist investor who could extract value by requiring that the poorly performing assets be divested. Li and Li’s (1996) model is probably the first theory that links firms’ scope changes and capital structure decisions made to minimize agency costs. One novel result is that their model determines simultaneously the extent of corporate scope and corporate financial structure. Because corporate scope affects firm size and its capital structure, altering scope through asset restructuring could reduce the volatility of cash flows and therefore increase the optimal leverage of the firm. Increasing leverage forces managers to pay out free cash flows without foregoing positive net present value (NPV) projects. Fluck and Lynch (1999) build a model on the idea that firms diversify first and then break up, and that, consequently, mergers and breakups are both mechanisms to enhance the efficiency of corporate control—since corporate scope directly affects the efficacy of the financial structure in disciplining management. In this model, a diversifying merger is value-increasing because it helps overcome agency conflicts between managers and potential claimholders when it comes to financing marginally profitable, possibly short-horizon projects as stand-alone entities. The model’s key empirical implication is that after a sequence of mergers, we should observe a sequence of asset sales. A different approach is developed in Matsusaka and Nanda’s (2002) model. They suggest that refocusing through a divestiture can serve as a credible way to commit resources to an industry in which the firm seeks to refocus, hence preventing entry by rivals. Eisfeldt and Rampini (2008) develop an analytical characterization of the effect of agency costs on capital reallocation and aggregate productivity, showing that agency conflicts between stockholders and managers make bad time worse because capital is less productively deployed. According to this model, managers are more reluctant to downsize in bad times when outside options deteriorate, and managerial agency costs are higher.

3.2

Financing Theory

Asset sales are often an efficient solution when firms have to deal with the consequences of debt overhang (Myers 1977), such as the choice of rescheduling debt or raising capital through a new security issue. Further, divestitures rarely result in an immediate reduction in total assets but often substantially increase liquidity for the divesting firms. This observation is significant from a shareholder’s perspective because, similar to free cash flow operations, cash proceeds from a sale can be reallocated to the unfunded projects of the divesting firm, even though management

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can exert significant discretion in that decision. Because capital market frictions to raise external financing are costly, an asset sale can foster positive NPV projects that can be financed with asset-sale proceeds (see Hite et al. 1987). At the same time, however, conflicts caused by owners’ personal interests as well as managerial conflicts of interest may redirect asset-sale proceeds to the financing of projects that benefit controlling shareholders and managers at the expense of minority shareholders. If the firm or the institutional setting lacks explicit statutory or legal constraints over asset sales, then managers may retain proceeds to benefit themselves (see Lang et al. 1995). However, the decision to retain cash from asset sales may be efficient if proceeds improve financial flexibility, particularly for firms facing uncertain or constrained access to internal or external capital markets (see Shleifer and Vishny 1992; Brown et al. 1994). After the financial crises of 2008–2011, new approaches to modeling asset sales emerged in the finance literature. Most of them emphasize the “financing role” of asset sales, particularly given macroeconomic risks and adverse financial market conditions that may increase external financing costs. Under such conditions, assetsale proceeds could complement or even be substituted for more traditional debt- and equity-financed investments. However, there is a dearth of theoretical models for the financing role of asset sales that recognize conflicts of interest and agency costs as important frictions in such strategic decisions. Thus, despite considerable progress in other areas of asset-sale theory, we see a need for further analysis of the underpinnings of the divestment process and in particular of the difference between the financing roles of asset sales in managerially controlled vs. owner-controlled firms. Furthermore, the even greater inherent conflicts of interest between shareholders and debtholders in divestiture decisions are also an area where asset-sale theory needs further development.

3.2.1

Macroeconomic Shocks

Arnold et al. (2018) develop a model where asset-sale proceeds are considered as a substitute for equity-financed investments. When a leveraged firm needs capital to fund a new project, it must consider its available growth options, equity costs, and the standard trade-off of transferring collateral/wealth value among debtholders and shareholders. All factors are business cycle-dependent, which makes them even more relevant when considering the financing role of asset sales. Arnold et al.’s (2018) model predicts that asset sales prevail over equity financing when firms have higher leverage and external markets are in a bad state. Although the divestiture will increase debt risk and exacerbate the bondholder-shareholder conflict, the asset-sale decision will be an optimal way to address other frictions that arise from asymmetric information, underwriting fees, and liquidation costs. Thus, on the one hand, financing with asset sales ameliorates the underinvestment problem (Myers 1977), even while, on the other hand, it increases the friction costs of selling assets (e.g., legal fees and liquidity costs). Thus, according to Arnold et al. (2018), firms must trade off

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the costs arising from transferring wealth among classes of security holders with the higher cost of selling assets.

3.2.2

Information Asymmetries

The classic Myers and Majluf (1984) adverse selection theory of asymmetric information between managers and capital markets, in the absence of agency conflicts, supports corporate cash holdings as a lower-cost substitute for capital raised in external markets. In this model, investors will provide additional capital only at a discount, and in extreme cases, debt overhang problems will prevent the issuing of new securities (Myers 1977; Myers and Majluf 1984). In this framework, adding to cash reserves through the retention of asset-sale proceeds can be efficient if it allows a firm to finance positive NPV projects even when internally generated free cash flow is insufficient. However, Shleifer and Vishny’s (1992) fire sales model predicts that the value of the option to fund projects using retained asset-sale proceeds is far greater for firms with financial constraints. Edmans and Mann (2019) develop a model following the asymmetric information setup that describes an asset sale as a valid alternative to an equity issue when external capital is required. Their model identifies the balance sheet effect, which helps establish a relation between the size of financing need and how to select between a security issuance and the sale of assets. However, in Edmans and Mann’s (2019) model, firms’ non-core asset valuation and growth opportunities, as well as the size of their financing needs, all play a crucial role in selecting investment financing. When the amount needed to finance investment is small, non-core asset sales are a preferable alternative to raising external capital, particularly for high-quality firms, which can frame the sale as dissynergistic (the authors call this strategy the camouflage effect). In this case, asset purchasers do not have claims on the entire firm, nor on the cash raised through the asset sale. Equity finance is preferred when firms have good growth opportunities, limited information asymmetries, and larger financing needs. In this scenario, the new security holders have claims on the entire firm, including the cash raised through the asset sale. This state of affairs helps reduce uncertainty about the valuation of the firm’s asset in place.

3.3 3.3.1

Asset Sales in Banking Loan Sales

The focus of most of the literature on asset sales has been on transactions in real asset markets. Consequently, frictions specific to real assets, such as their higher illiquidity and information asymmetry, are central to a large part of asset-sale theory. For example, Shleifer and Vishny’s (1992) capstone model uses an indebted farmer

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example to present their intuition, and it is based on the key role of nonexpert buyers in obtaining an equilibrium in a specialized corporate real asset market. Are all those factors relevant when discussing sales of financial securities? After all, financial securities are frequently relatively more liquid and do not require any skill or knowledge to manage the assets they finance. However, a special class of financial security, loans, issued by a special type of firm, banks, characterizes financial markets. A bank’s typical investment is a loan to an enterprise. Thus, a strand of asset-sale literature has emerged to model this special class of bank loan transactions. Under the pure theory of financial intermediation, a bank will not sell its loans because of moral hazard problems. This theory (e.g., Diamond 1984; Boyd and Prescott 1986) predicts that banks originate loans that they should be unable to sell. This is a classical Akerlof (1970) “lemons” market problem, and the consequent moral hazard problem cannot be mitigated through the bank’s efforts. Nevertheless, since the early 1980s, the bank loan sale market has been booming in many countries. A combination of reduced transaction costs, regulatory changes, and intensified industry competition have been the catalyst for the opening of the loan sale market. Under this new scenario, the primary source of internal bank financing (i.e., deposits) becomes costlier, thus creating incentive for the bank to seek external funding through divesting loans. Selling loans becomes relatively inexpensive for some “standard” categories of loans, originated by certain banks. Pennacchi (1988) is the first attempt to model bank loan sales, taking stock of the ongoing changes in the commercial banking industry. Pennacchi’s research question is: What incentives exist for banks to market a non-marketable asset, which their loans typically are? His model shows that loan sales allow banks to finance loans at a lower cost than traditional bank deposits and equity issues. However, a further motivation comes from signaling bank theory, which argues that signaling loan quality through loan sales (e.g., Greenbaum and Thakor 1987) can further enhance bank quality and competitiveness. Further, empirical evidence (James 1987) shows that selling loans provides lower costs of financing for bank equity holders, avoiding classical corporate finance underinvestment problems when the bank has outstanding risky debt. In addition, regulatory reasons may incentivize banks to sell loans, because examination procedures require them to hold only certain asset risk classes while permitting them to sell the rest profitably. Pennacchi’s model goes further, suggesting that banks will have fewer incentives to monitor and service loans after they have been sold, with the only constraint on taking an active role in the loan sale market being “moral hazard problems.” Pennacchi’s model relies on financial contracting to address that trade-off, so that banks can alleviate moral hazard problems by writing “more optimally designed” contracts with loan buyers. When a bank offers loan buyers an incentive-efficient loan sale contract, the bank’s loan sales volume, and hence its profitability, can be maximized. Bank loan buyer contracts “with no recourse” are contracts in which the bank cannot pledge outside assets as a potential payment to the loan buyer. Only the proceeds of the loan return are permitted to be split between the bank and loan buyer. Usually, the Federal

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Reserve places restrictions on loans sold with recourse, and in practice, the majority of loan sales are made without recourse. There are some market examples, including Bank One’s sale of promised payments from a pool of credit card receivables. In that case, the bank retained an equity position in the pool of credit card receivables; this equity position was equal to twice the historical default level of the receivables. A similar contract was designed by Coast Savings and Loan, a California thrift that originated the mortgages. It retained a junior 20% interest in the pool and then sold a senior interest in the pool of adjustable rate commercial mortgages. In these examples, then, bank loan sales involved higher-quality assets that need less ex post monitoring. Buyers of bank loans include a growing number of nonbank financial institutions and nonfinancial corporations, although frequently large bank loans are purchased by small local banks that have fewer opportunities to originate loans. Pennacchi (1988) concludes that it may be unwise for regulators to discourage loan sales unconditionally. Given the uniqueness of bank capital structure and the benefits of bank asset diversification derived from a greater number of originated loans, the higher risk incurred on each individual loan should be set against the increased efficiency and liquidity of the bank asset portfolio. Gorton and Pennacchi (1995) model contracting between banks and loan acquirers by considering the agency costs of selling loans. Gorton and Pennacchi highlight financial market conditions and institutional setting changes that have been facilitating the growth of a market for loans. For example, the selling bank retains a fraction of the loan and gives the loan buyer(s) implicit enforceable guarantees against default. Their model predicts that deposit market competition will increase aggregate loan sales, even though loan acquirers will demand a competitive rate of returns on the loans they purchase. Furthermore, one key advantage of a loan sale with respect to attracting deposit inflows is that funds obtained from loan divestitures, unlike deposit funds, avoid costs associated with bank reserves and capital requirements. An extension of Gorton and Pennacchi’s (1995) theory is to model the partial asset sale in the loan market. Allowing banks to sell only part of a loan and retain the rest reduces agency problems and increases their incentive to keep monitoring the borrower. This is the course that the bank industry has been following ever since, through loan contract syndications and bank network arrangements. Carlstrom and Samolyk (1995) have a different view of the loan sale market. In their model bank loans originate “à la Diamond (1984),” in the sense that bankers have a comparative advantage in locating and screening certain risky projects. Thus, localized information creates incentives for some banks to initiate lending. However, those banks face limits to their capacity for on-balance-sheet intermediation; they will sell loans rather than fund them with costly and limited capital on their balance sheets. Because local banks have a limited number of projects they can fund onbalance-sheet due to limited monitoring resources, they will make loans only on risky projects for which their capital can buffer potential losses. The model of Carlstrom and Samolyk (1995) introduces smart and capitalized buyers into the loan sale market. They are bankers with excess capital who purchase risky projects originated by capital-constrained banks. In equilibrium, loan asset sales generate

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positive yield differentials for originating banks through the process of separating returns between origination, on the one hand, and loan performance captured by loan acquirers, on the other hand. Thus, a market in loan sales will occur, and its equilibrium is obtained because of the information advantage of local bankers traded against the excess capital of other (outside) bankers. Parlour and Plantin (2008) model an ex ante liquid loan sale market assuming that moral hazard problems in lending are reduced through monitoring and, more critically, through banks’ incentives to be able to redeploy capital invested in loans in more attractive investment opportunities. Thus, their model is based on the difficult equilibrium between banks’ willingness to exploit the informational benefits of clientele relationship, on the hand, and their desire to be in a position to lower their monitoring costs and obtain the benefits of increased liquidity and capital flexibility offered by an efficient loan sale market, on the other hand. This model makes several empirical predictions. One effect is to be observed in pricing credit risk. In that setting, credit spread will reflect both (unconditional) issuer default probability and the bank’s (conditional) willingness to sell originated firm loans. When credit spread is so identified and split into its two components, the price discovery function of the secondary loan market will generate a liquidity premium. Parlour and Plantin’s (2008) model has interesting testable implications for the activity of both bond and loan markets. To start, secondary loan markets develop because of regulatory changes and their growth in size and liquidity will have effects on various segments of firms’ debt issues. The first implication is that trading volume in secondary loan markets will be larger for high-grade borrowers. Second, a more liquid loan market will become more price-efficient and will have implications for borrowers’ issuing public bonds as those securities are relegated to a minor role in capital structure decisions. Such a liquid market will have two opposite effects on the cost of bank debt. On the one hand, the cost will be lower because the bank will no longer charge a liquidity premium. But on the other hand, banks will have an incentive to monitor borrowers and exploit the informational rents (as in Rajan 1992) generated by lending. These outcomes will increase firms’ incentive to borrow from banks at a lower interest rate and, simultaneously, the liquidity of the loan sale market. He (2009) models financial intermediaries’ sale of assets in a portfolio context, when information asymmetries require them to send credible signals about the assets’ quality to financial markets. He (2009) relies on Leland and Pyle’s (1977) classical information theory, which is based on the key assumption that asset quality is linked to the entrepreneur’s retained amount. The model generalizes Leland and Pyle’s result and offers a framework for analyzing the interdependence between asset selling and risk management by financial intermediaries. He’s (2009) model generates novel predictions, specifically for the loan sale market. An intermediary with a more diversified loan portfolio faces a more liquid financial market and a lower sale price impact. This effect is obtained because, in a portfolio-based measure, the key determining factor for the asset’s equilibrium price should be the asset’s risk contribution relative to the bank’s existing portfolio. He’s (2009) insights could

3.3 Asset Sales in Banking

25

also be applied to other types of financial intermediary asset sales, such as when private equity funds sell shares of their invested companies. Parlour and Winton (2013) develop an alternative model of a loan sale market that coexists with a parallel credit derivative market. Essentially, theirs is a model that trades off benefits and costs of loan sales versus hedging credit risks. Currently, banks can approach financial markets to undertake two different kinds of transactions to unload risk from their lending activity: they can sell the originated loan or negotiate a credit default swap (CDS). However, when the bank sells the loans, it transfers to the buyer both debt cash flow rights and control rights. With a CDS, the bank transfers only cash flow rights and retains the loan’s control rights. In this model, there are three key assumptions tied to important institutional aspects. First, bank loans are typically protected by numerous covenants, which give banks de facto control through the threat of default. Second, the growth of CDS markets makes it possible to lay off loan credit risk cheaply and anonymously over a longtime horizon. Third, as banks are repeated lenders, their reputation in the loan market is crucial when it comes to indicating their ability and efficiency in monitoring borrowers. Parlour and Winton (2013) combine these elements, and their model obtains the following results. First, because banks can exploit the potential of credit risk management, they will do more monitoring for riskier loans but less for safer credits. Second, unbalanced monitoring activity will increase the cost of equity capital for banks. Third, banks will rely more on the loan sale market to off-load riskier credits, while using CDS for safer loans. Fourth, since banks care about their reputation in the lending market, safer credits will be hedged in the CDS market, even though they would receive better monitoring in the credit market—monitoring that allows for efficient sharing and repeated presence. Different market equilibria will obtain depending on how well loan buyers monitor borrowers’ loans. If buyers are good at monitoring, then the loan sale market will dominate CDS, and the bank no longer has any economic incentive to monitor. But if buyers are unable to monitor, then the loan sale market and the CDS market will coexist, although the level of bank monitoring will be low. The model has empirical implications for outcomes in the loan, borrowing rate, and credit risk markets. The introduction of CDS is counterproductive for risky firms and will lead to increases in their borrowing costs. By contrast, the availability of CDS for safer borrowers is efficient and leads them to improve their borrowing rates.

3.3.2

Fire Sales

The theory of fire sales (Shleifer and Vishny 1992) suggests two critical conditions for a fire sale. First, the sale is a forced sale. Second, the natural (industry) buyers of the assets are also in distress, which makes it difficult for them to access credit. The obvious consequences of fire sales are (a) the asset is sold at a discount relative to its

26

3

Asset Sales in the Theory of Finance

fundamental value; (b) it is unlikely that the buyer is from the same industry; and (c) the price of the asset, after the sale, will recover toward its fundamental value. Research interest in fire sales in banking picked up after the recent financial crises of 2008 (subprime markets) and 2011 (sovereign markets). During a financial crisis, potential buyers of bank assets often have limited resources because of a dramatic decrease in lending. That situation gives rise to the deviation of sale prices from fundamental values, and a fire sale happens. The obvious research question that emerged from this state of affairs is the following: What happens when a bank is forced to sell assets at times of financial crises, when market conditions are not optimal for it to execute orderly, efficient sales and obtain fair prices? This scenario is similar to that modeled in Shleifer and Vishny (1992), and such forced sales may happen when potential bidders are involved in the same economic activity (i.e., the potential bidders would be other banks). However, potential bidders cannot borrow to buy the asset, and they might be selling similar assets themselves. As a consequence, assets sold under those conditions are liquidated at fire-sale prices, triggering a cascade of fire sales, inflicting losses on many financial institutions, and eliciting disruptions in financial and real asset markets with effects that can propagate to the whole economy (see the review in Shleifer and Vishny 2011). The model of Diamond and Rajan (2011) tackles exactly this scenario, addressing the negative consequences of cascades of asset sales in a banking system that may generate worse fire sales and a large drop in lending, with consequential effects not only across the banking industry but also throughout the real economy. The starting assumption of Diamond and Rajan (2011) is a liquidity shock that forces banks into fire sales of their assets, because potential buyers have limited financial resources. Next, fire sales may force banks to call in bank-specific loans to enterprises and to increase interest rates to attract deposits from other banks. The sequence of worse and worse fire sales, credit contraction, and deposit competition will bring down many other banks, further reducing the bank system’s liquidity and requiring central bank intervention. In fact, Shleifer and Vishny (2010a, b) model central bank intervention through security purchases to limit the cascade effects of fire sales and the weakening of the whole banking system. In falling markets, fire sales drive down the prices of assets serving as collateral, the equity of the banks is wiped out as they seek to maintain their holdings, and banks cannot borrow more in private markets. In this scenario, the efficient way of restoring bank loans to real markets is to increase asset prices so that financial investment no longer dominates lending. Alternative ways of restoring lending to real sectors, such as by injecting new capital into banks, will not by themselves restart lending, because banks will merely use the capital to hold onto or acquire more of these distressed assets. As Shleifer and Vishny suggest, the bright side of that type of intervention is to recover credit markets; but its dark side is that it will perhaps take place first in a kind of shadow banking system, circumventing entirely the weaker banking sector. In the model of Bolton et al. (2011), asset sales happen when intermediaries need to liquidate longer-horizon assets to meet liquidity demands that cannot be resolved with their own cash reserves (inside liquidity). Defining asset sales as outside

3.3 Asset Sales in Banking

27

liquidity, Bolton et al. (2011) model the choice between the two sources of liquidity in a competitive equilibrium within the financial sector. Given that there is asymmetric information between investors in short-term vs. long-term assets of financial intermediaries, there will be frictions in the decision-making of the two groups of investors. When a liquidity crisis hits the financial sector, the degree of adverse selection in financial markets becomes important. If adverse selection problems are not severe, financial intermediaries can wait, delaying asset sales at discounted prices (fire sales)—particularly when the crisis is mild. But if a liquidity crisis worsens, Bolton et al.’s (2011) model shows that intermediaries would be better off committing ex ante to liquidate assets at depressed prices in the distressed state. In parallel with other models discussed previously, Bolton et al. (2011) suggest that the resolution of lemon problems in a financial crisis can only be solved through the help of public provision of liquidity. Caballero and Simsek (2013), for their part, develop a model where fire sales occur even when market liquidity is high and the shock is small relative to the wealth of the financial network. Their model centers on the degree of complexity of a financial system. A complex financial market, even during normal times, can generate uncertainty in banks about the extent of network cross exposures and their economic consequences. Caballero and Simsek’s model predicts powerful feedback between bank fire sales and financial market complexity. More distressed fire sales amplify the domino effects and increase the risk to banks’ counterparties. This in turn will prevent potential buyers from participating in the fire sale market, exacerbating the negative effects of fire sales. The model’s policy implications are that more complex financial networks require both preemptive actions before crises erupt and government actions during crises, whether by bailing out distressed banks or by taking an active role as buyers in the bank loan market. Greenwood et al. (2015) model fire sales in banking, showing how distressed asset sales may propagate liquidation spirals and spread contagion that will likely impair other banks’ balance sheets. Their model relies on banks’ size and leverage. The larger a bank’s balance sheet and leverage, the higher will be its degree of connectivity and systemic risk. When larger banks approach asset-sale markets to divest, the asset price impact will be larger; that impact will spill over to other banks, which will have to mark down the same assets in their balance sheets. This model, too, has relevant policy implications. Regulators can choose either to force mergers to avoid a cascade of fire sales, triggered by larger, interconnected, and vulnerable banks, or distribute shares of equity infusion from government sources across the banking system, proportional to banks’ degree of vulnerability. Their empirical evidence for a sample of European banks during the sovereign crisis shows that even modest, albeit appropriately distributed, government equity injections can significantly reduce risk in this sector. Dow and Han (2018) model fire sales of financial assets during times of financial crisis. In their model, specialized informed investors are of two types: distressed firms that seek to liquidate assets quickly and firms that manage arbitrage capital but only during normal market conditions. When a financial crisis happens, distressed specialized investors try to sell only overvalued assets, while arbitrageurs become liquidity-constrained and will not participate. The result is a market freeze, with

28

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Asset Sales in the Theory of Finance

prices falling and becoming uninformative—and further incentivizing sellers to supply only overvalued assets to the market. Dow and Han’s (2018) model assigns an important role to two types of uninformed investors: hedgers and risk-neutral investors. In this model, fire sales happen because they will be absorbed by uninformed investors rather than informed arbitrageurs. The key aspect of this theory is that even a small amount of informed capital can promote liquidity, as long as it makes prices sufficiently informative.

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Hege U, Lovo S, Slovin MB, Sushka ME (2009) Equity and cash in intercorporate asset sales: theory and evidence. Rev Financ Stud 22(2):681–714 Hite GL, Owers JE, Rogers RC (1987) The market for interfirm asset sales: partial sell-offs and total liquidations. J Financ Econ 18(2):229–252 James C (1987) Some evidence on the uniqueness of bank loans. J Financ Econ 19(2):217–235 Klein B, Crawford RG, Alchian AA (1978) Vertical integration, appropriable rents, and the competitive contracting process. J Law Econ 21(2):297–326 Lang L, Poulsen A, Stulz R (1995) Asset sales, firm performance, and the agency costs of managerial discretion. J Financ Econ 37(1):3–37 Leland HE, Pyle DH (1977) Informational asymmetries, financial structure, and financial intermediation. J Financ 32(2):371–387 Li DD, Li S (1996) A theory of corporate scope and financial structure. J Financ 51(2):691–709 Maksimovic V, Phillips G (2002) Do conglomerate firms allocate resources inefficiently across industries? Theory and evidence. J Financ 57(2):721–767 Matsusaka JG, Nanda V (2002) Internal capital markets and corporate refocusing. J Financ Intermed 11(2):176–211 Meyer M, Milgrom P, Roberts J (1992) Organizational prospects, influence costs, and ownership changes. J Econ Manag Strateg 1(1):9–35 Myers SC (1977) Determinants of corporate borrowing. J Financ Econ 5(2):147–175 Myers SC, Majluf NS (1984) Corporate financing and investment decisions when firms have information that investors do not have. J Financ Econ 13(2):187–221 Nanda V, Narayanan M (1999) Disentangling value: financing needs, firm scope, and divestitures. J Financ Intermed 8(3):174–204 Parlour CA, Plantin G (2008) Loan sales and relationship banking. J Financ 63(3):1291–1314 Parlour CA, Winton A (2013) Laying off credit risk: loan sales versus credit default swaps. J Financ Econ 107(1):25–45 Pennacchi GG (1988) Loan sales and the cost of bank capital. J Financ 43(2):375–396 Rajan RG (1992) Insiders and outsiders: the choice between informed and arm’s-length debt. J Financ 47(4):1367–1400 Salgado P, Carrasco V, De Mello JMP (2017) Product market competition and the severity of distressed asset sales. Rev Financ 21(5):2007–2043 Servaes H (1991) Tobin’s Q and the gains from takeovers. J Financ 46(1):409–419 Shleifer A, Vishny RW (1992) Liquidation values and debt capacity: a market equilibrium approach. J Financ 47(4):1343–1366 Shleifer A, Vishny RW (2010a) Asset fire sales and credit easing. Am Econ Rev 100(2):46–50 Shleifer A, Vishny RW (2010b) Unstable banking. J Financ Econ 97(3):306–318 Shleifer A, Vishny R (2011) Fire sales in finance and macroeconomics. J Econ Perspect 25 (1):29–48 Slovin MB, Sushka ME, Polonchek JA (2005) Methods of payment in asset sales: contracting with equity versus cash. J Financ 60(5):2385–2407 Tirole J (2006) The theory of corporate finance. Princeton University Press, Princeton, NJ Travlos N (1987) Corporate takeover bids, methods of payment, and bidding firms’ stock returns. J Financ 42:943–963 Warusawitharana M (2008) Corporate asset purchases and sales: theory and evidence. J Financ Econ 87(2):471–497 Williamson OE (1975) Markets and hierarchies: antitrust analysis and implications. Free Press, New York Yang L (2008) The real determinants of asset sales. J Financ 63(5):2231–2262

Chapter 4

Empirical Perspectives on Asset Sales

Abstract In this chapter, we review the main findings of empirical studies of asset sales. Nonfinancial firms generally sell individual assets or a portfolio of real assets (e.g., timberland, natural resources, buildings, ships, airplanes, factories, plants, machinery, equipment), while banks can sell either real or single financial assets or a portfolio/package of them (e.g., treasury securities, bank loans, equity stakes, derivative portfolios). However, it is not uncommon for firms to dispose of complex combinations of real, financial, and human capital assets (e.g., product divisions, bank branches, trading desks, asset management units). We provide empirical evidence supporting both the efficiency theory and financing theory for both types of sellers. Keywords Asset sale · Banks · Corporate focus · Corporate governance · Financing asset · Financially constrained firms · Nonfinancial firms · Liquidity and industry transformation · Loan sales · Shareholder wealth

4.1

Introduction

Scholars’ development of empirical perspectives on asset sales began to flourish with the estimation of stock return effects around restructuring activity announcements. Studies have considered both the seller’s and buyer’s side, as well as their ex ante and ex post operational and financial performance. There is a substantial body of empirical research in this area that has accumulated over the last three decades; the research seeks to understand whether divestitures create net value between the firms involved and also how the gains or losses from these transactions are shared between acquiring and divesting firms. Earlier studies rely on evidence from a small sample of divestitures made in the early 1980s, while more recent papers use large transaction databases and more sophisticated methods to address endogeneity issues. We will present the empirical literature following the same structure adopted in the review of work on asset sales in the theory of finance (Chap. 3). However, the

© The Author(s), under exclusive licence to Springer Nature Switzerland AG 2020 C. Curi, M. Murgia, Asset Sales, SpringerBriefs in Finance, https://doi.org/10.1007/978-3-030-49573-2_4

31

32

4 Empirical Perspectives on Asset Sales

empirical literature is more extensive, because several hypotheses have been tested empirically. We summarize the main findings of the literature reviewed in Tables 4.1 and 4.2. As with the theoretical studies discussed in Chap. 3, the empirical studies are categorized into two streams, one referring to the efficiency theory and the other to financing theory. Of course, these explanations cannot be considered in isolation; rather, they need to be viewed as parts of a larger, integrated framework. For the sake of simplicity and clarity, however, we present them as separated. Stock price reactions, most of them expressed in terms of cumulative abnormal returns (CARs) of the divesting and acquiring firms around the announcement, are reported (if available). So, too, is information about additional methods used to assess the market and productivity-based consequences of firms selling assets. Various methodological approaches have been used in the empirical literature; those approaches have also evolved over time, increasing in econometric complexity and data variety. Some work analyzes stock reactions as a measure of value creation through asset sales, grounding the analysis on event study methodology. Other work considers the impact of asset sales transactions in terms of productivity changes, comparing assets traded in the corporate asset markets with assets remaining at the selling firms. Still other analyses study the determinants of the probability of asset sales. The most recent contributions to the field combine all three methodologies to address their research questions. Lastly, there are several studies that focus on issues related to the endogeneity of the decisions about asset sales and others that highlight the difficulties of defining a sale of specific assets using accounting measures. The presentation of the empirical studies follows the order in which these different approaches were developed in the literature, chronologically speaking.

4.2

Empirical Research on the Efficiency Theory of Asset Sales

Asset sales might contribute to the efficient asset management of firms and industry in general. Asset sales could be adopted to improve directly the efficiency of the firms’ remaining assets and indirectly the efficiency of the sold assets being reallocated to other firms, which can better exploit their usage. The empirical evidence related to asset reallocation in such contexts refers to the efficiency theory. We identify three streams of work in this area, each of which deals with different market frictions: information asymmetries, industry-related issues, and conflicts of interest and agency costs. Table 4.1 (Panels A–C) summarizes the main findings related to the efficiency theory.

Methods of payment

Corporate focusing

Shareholder wealth creation

1963– 1981

1971– 1982

1980– 1991

Hite et al. (1987)

Kaplan and Weisbach (1992)

Slovin et al. (1995)

Slovin et al. (2005)

1982– 2000

1983– 1994

1970– 1979

Klein (1986)

Dittmar and Shivdasani (2003)

1976– 1978

Jain (1985)

1986– 1988

1969– 1981

Rosenfeld (1984)

John and Ofek (1995)

1964– 1973

Time period

Alexander et al. (1984)

Panel A: Information asymmetries

Efficiency theory

USA

USA

USA

USA

USA

USA

USA

USA

USA

USA

Country

327

188

258

179

27 unsuccessful asset sales; 40 successful asset sales

59 unsuccessful asset sales; 55 successful asset sales

202

1062

62

53

Sample size

Table 4.1 Summary findings related to the efficiency theory

3.17% equity asset sales; 1.9% cash asset sales

3.40%

1.50%

1.70%

5.39% unsuccessful; 2.05% successful

1.41% unsuccessful; 1.66% successful

1.10%

0.50%

2.33%

0.30%

Seller

CARs

9.77% equity asset sales; nss. cash asset sales

nss

0.36% unsuccessful; 0.83% successful

3.40%

2.10%

Buyer

[ 1;0]

[ 1;+1]

[ 2;0]

[0;+1]

[ 2;+2]

[ 1;0]

[ 2;0]

[ 1;0]

[ 1;0]

[ 1;0]

Event window

Linear regressions

Linear regressions

Linear regressions

Linear regressions

Econometric methods

(continued)

Method of payments Corporate blockholding

Change in investment policy Change in focus

Change in diversification discount Excess returns

Change in focus

Change in focus

Asset sale size Price announcement Agreement announcement

Main explanatory variables

Change in investment policy

CAR

CAR

Dependent variable

4.2 Empirical Research on the Efficiency Theory of Asset Sales 33

Çolak and Whited (2006)

Hege et al. (2009)

Economic change and industry shocks

Asset and firm productivity

Asset liquidity

1990– 1999

1986– 2000

Powell and Yawson (2005)

1984– 2004

Warusawitharana (2008)

Mulherin and Boone (2000)

1974– 1992

1979– 1994

Schlingemann et al. (2002)

Maksimovic and Phillips (2001)

1982– 1988

1983– 1994

1989– 2002

Time period

Kim (1998)

Panel B: Industry-related issues

Endogeneity and measurement issues

Efficiency theory

Table 4.1 (continued)

UK

USA

USA

USA

USA

USA

USA

USA

Country

1294 whole sample;

139

109,000 whole sample; 13,000 buyer firms; 5000 seller firms

35,291

168

481

267

130

Sample size

2.60%

Several types of evidence

6.92% equity asset sales; 1.43% cash asset sales

Seller

CARs 3.44% equity asset sales; nss. cash asset sales

Buyer

[ 1;+1]

[ 1;0]

Event window

Linear regressions

Asset sales rate

Asset sale quantity

Endogenous selection model Inter-industry variation analysis

Categorical variable if assets are bought, are sold, or are neither

Binary variable if plants are sold

Binary variable if segments are sold

Logistic regressions

Production function estimation
Probit regressions

Logistic regressions

Binary variable if assets are sold

Broad industry shocks

Tobin’s q

Profitability Cash flow

Aggregate industrial production Plant productivity Segment productivity

Segment liquidity index Maximum liquidity index

Interest coverage ratio % liquid assets % illiquid assets

Binary variable if assets are sold

Excess value Investment efficiency

Treatmenteffect estimation Probit regressions

Forecast error

Seller bid ask spread Seller trading value

Main explanatory variables

Binary variable if assets are sold

Methods of payment

Dependent variable

Probit regressions

Logistic regressions

Econometric methods

34 4 Empirical Perspectives on Asset Sales

1974– 2000

Yang (2008)

Corporate governance

1975– 1982

1985– 1993

1981– 1995

1985– 1992

1982– 1992

1997– 2005

1994– 1998

Hirschey and Zaima (1989)

Berger and Ofek (1999)

Hanson and Song (2000)

Denis and Kruse (2000)

Datta et al. (2003)

Owen et al. (2010)

Kang et al. (2010)

Panel C: Conflicts of interest and agency costs

1985– 1994

Denis and Shome (2005)

KR

USA

149

797

113

350

USA

USA

326

320

170

1,400,000

130

USA

USA

USA

USA

USA

947 takeovers 562 asset sales

3.4% economic shock; nss. during performance decline

1.57%

1.63% shareholders; 0.54% bondholders

1.75%

0.60%

7.30%

2.83% closely held firms; nss. widely held firms

1.74% shareholders; 0.35% bondholders

0.47%

[ 1;+1]

[ 1;+1]

[ 1;0]

[ 1;+1]

[ 1;+1]

[ 1;+1]

[ 1;0]

Binary variable if a restructuring action occurs

Binary variable if assets are sold

Logistic regressions Logistic regressions

CAR

CAR

CAR

Excess value

Asset sales rate (I step) Industry fixed effects (II step)

Binary variable if assets are sold

Linear regressions

Linear regressions

Linear regressions

Logistic regressions

Linear regressions (two-step estimation)

Logistic regressions

(continued)

Equity ownership debt claims

Governance index Entrenchment index

Governance index Entrenchment index

Combination measures of bidder and seller by Tobin’s q

Managerial ownership Board of director composition

Diversification Segments relativeness

Time-variant firmspecific factors (I step) Shock persistence Shock dispersion (II step)

Industry sales shock

Specific industry shocks

4.2 Empirical Research on the Efficiency Theory of Asset Sales 35

1974– 1982

1981– 2004

1986– 2009

1990– 2011

Tehranian et al. (1987)

Huang (2014)

Chiu et al. (2016)

Humphery-Jenner et al. (2019)

Time period

Note: “nss” stands for not statistically significant

Management performance and compensation structure

Efficiency theory

Table 4.1 (continued)

USA

USA

USA

USA

Country

6216

1456

423

146

Sample size

0.89%

0.63% more experienced CEO

0.88% with long-term plan; 0.61% without longterm plan

Seller

CARs Buyer

[ 1;+1]

[ 1;+1]

[ 1;+1]

Event window

Binary variable if non-core, distant, and underperforming units are sold CAR

Linear regressions

Degree of refocusing

Linear regressions Logistic regressions

CEO change New internal CEO

Total number of asset sales

Negative binomial regressions

Divestiture experience

Divestiture experience

CEO change New internal CEO

Match between the CEO’s expertise and firm assets

Change in excess value and return on assets

Main explanatory variables

Specialized CEO

Dependent variable

Binary variable if a segment sale

Logistic regressions

Econometric methods

36 4 Empirical Perspectives on Asset Sales

4.2 Empirical Research on the Efficiency Theory of Asset Sales

4.2.1

37

Information Asymmetries

Within this stream, some empirical papers test measurements of shareholder wealth creation, while others test the corporate focus explanation. Moreover, we find papers focusing on the econometric issues related to endogeneity and measurement problems in general.

4.2.1.1

Measurement of Shareholder Wealth Creation

Pioneering papers on asset sales investigate their valuation effects. The main hypothesis examined is that in the case of voluntary corporate sell-offs, the stock price of the firm experiences an abnormal upward movement as the result of a positive net present value investment. Overall, however, the findings are mixed. Alexander et al. (1984) examine a small sample of 53 firms and find positive but weak excess returns to the stockholders of the selling firms, especially when compared to spin-offs. The slightly positive impact can be explained either by the simultaneous announcement of other negative information released about the firm— negative information that mutes the positive impact news about the sell-offs should have—or by a perfectly competitive market for sell-offs. Rosenfeld (1984) expands the previous work, finding that the excess returns associated with both asset sales and spin-offs tend to have a positive effect on the stock prices of the divesting firms, though spin-offs outperform sell-offs on the day of the event. Moreover, he finds that shareholders of selling and acquiring firms share nearly equally in the transaction, highlighting how, in contrast with mergers, asset sales’ synergistic effects are not restricted to the selling firm. Jain (1985) enriches the analysis, showing that both sellers and buyers earn significant positive excess returns from asset sales and that asset sales are preceded by a period of significant negative returns for the sellers. Klein (1986) investigates the discrepancies in announcement day excess returns for the selling firms, isolating factors, such as the relative size of the divestiture and whether the transaction price is initially announced, behind the differences in share price responses. Her findings show that a positive relation exists between the relative size of the divestiture and the announcement returns and a more significant announcement return when the transaction price is revealed. Subsequent price disclosures, though, produce insignificantly abnormal returns. Along the same lines, Hite et al. (1987) enrich the analysis by studying a sample of 55 successful and 59 unsuccessful asset sales. In 55 successful sales of subsidiaries and divisions from 1963 to 1981, successful asset sales’ generally positive valuation effects were equal to +1.66% at the announcement of the sell-offs and +0.82 at the announcement of the completed outcome. Unsuccessful sellers realized gains at the bid announcement of +1.41% that were lost ( 0.95%) when the bid failed. In comparison, successful bidders earned abnormal returns of +0.83%, while unsuccessful bidders gained an insignificant +0.36%. This empirical evidence is also

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indirectly tested by Kaplan and Weisbach (1992), who evaluate the extent to which divestitures in the 1980s represent unsuccessful or failed acquisitions. They consider asset sales that were consequences of diversifying mergers; these assets were not shareholders’ value generators and were therefore later divested. They find that divestiture rates by purchasers are higher (almost four times) when targets are not in businesses related to the acquirers’. Moreover, the median time between the acquisition and subsequent divestiture is 7 years. Their findings suggest that acquisitions are usually followed by divestitures, whose frequency tends to increase with the occurrence of merger waves. Slovin et al. (1995) examine the valuation effects on firms in the same industry (competitors) and find that rival stock returns are normal for asset sell-offs, as compared to negative returns in response to equity carve-outs. This means that divesting assets via a sell-off transaction does not lead to a revaluation of industry assets, whereas such revaluations do occur in the case of carve-outs.

4.2.1.2

The Corporate Focus Explanation

Beginning with Comment and Jarrell (1995) and Lang and Stulz (1994), scholars have investigated corporate diversification across firms in an attempt to understand whether and how diversified firms are able to create value. Berger and Ofek (1995) find a negative relation between diversification and shareholder value. However, the loss in value is considerably less for related diversification due to overinvestment in segments from industries with limited investment opportunities (measured by a low Tobin’s q ratio); the loss in value is also less in the case of cross-subsidization of poorly performing divisions by better-performing divisions. Berger and Ofek (1995) show that when a firm increases in focus, the market value increases as well. This explanation is strictly related to corporate diversification and postulates that diversified firms trade at a discount because managers undertake value-decreasing investments and subsidize poor segments by draining resources away from valuable segments. Further, diversification can create a misalignment between central managers’ and division managers’ incentives. This line of inquiry predicts that divestitures that increase focus might lead to large improvements in investment policy. The empirical literature in this stream directly documents the positive impact of asset sales on the performance of diversified firms that sell assets outside their core business and become more efficient by reducing their degree of diversification. By studying a sample of 321 asset sales over the period 1986–1988, John and Ofek (1995) show that divestitures undertaken to make the seller more focused improve the operational performance of the remaining assets in each of the 3 years following the asset sales. Their findings support the efficiency theory argument, showing that sellers’ announcement return is positively and significantly related to the cash flow changes for the remaining assets. In terms of valuation effects, their findings show that the average cumulative excess return to the seller during the 2 days preceding versus the day of the asset sales announcement is positive (+1.5%) and also positively related to different measures of increase in focus. Moreover,

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returns for firms that divested unrelated assets are +2.4% higher than returns for firms that divested related assets. When both the focus and the efficiency explanations hold, they show that the average seller’s abnormal return is highest (+2.7%) when the divested division is related to the buyer and unrelated to the seller (relatedness-increasing group) and is lowest ( 2.2%) when the divested division is unrelated to the buyer and related to the seller (relatedness-decreasing group). Berger and Ofek (1999) confirm that the valuation consequences of diversification strongly affect the probability of asset sales, as found by John and Ofek (1995), concluding that unrelated diversification is most damaging. However, their empirical evidence is more in favor of the agency cost explanation, which we will discuss in Sect. 4.2.3. Dittmar and Shivdasani (2003) investigate how firms respond to divestitures that significantly change the degree of diversification, by examining the change in the diversification discount, stock returns, and investment policy. To this end, their sample includes firms that remove a segment by initiating a divestiture program or engaging in multiple asset sales. They find that returns on divestiture announcements are significantly correlated with changes in the diversification discount and that a larger decrease in diversification generates higher announcement returns. They distinguish between diversified parent firms and single-segment parents. The former sample consists of firms that remain diversified after the divestiture. The singlesegment parent’s subsample consists of firms with only one ongoing segment after the divestiture. They find that firms that become single segment show a higher drop in discount after the divestiture (mean discount in year t 1 before the divestiture equals +0.23; mean discount in year t+1 after the divestiture equals +0.14). In terms of valuation, in general Dittmar and Shivdasani (2003) find higher CARs for asset sales announcements than those documented in prior studies. This is because they analyze divestitures associated with the elimination of the entire business segment. They distinguish between CARs for each asset sale announcement and cumulative CARs for each firm. The CAR ranges from +2.2% to +3.4% for the full sample, depending on the event window; further, no significant difference across diversified and single-segment parents is found. The average cumulative CAR for all asset sales is +4.2% for the entire sample. The average cumulative CAR is virtually identical for diversified and single-segment parents. Compared to previous findings, these CARs are higher, because the sample contains relatively larger divestitures1 that are associated with a decline in an entire business segment. Overall, this line of empirical research is consistent with the corporate focus explanation, since it shows significantly positive shareholder effects and improvement in capital allocation for remaining business segments. Moreover, it reveals significant changes in the investment policy of firms’ remaining segments around the divestiture. Relative to stand-alone firms, investment increases for those segments that were underinvesting prior to the divestiture, and the segment investment becomes sensitive to segment growth opportunities after the divestiture. This trend

1

The average transaction value is $123.5 million.

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suggests that divisional investment policy becomes more efficient after the divestiture.

4.2.1.3

Endogeneity and Measurement Issues

Two problems may contaminate the empirical results when proxies for shareholder wealth creation are estimated. These are the endogeneity of the decision to sell assets and measurement error vis-à-vis investment efficiency. Çolak and Whited (2006) contribute to this literature by tackling these issues and test whether previous findings still hold. They confirm that improvement in efficiency follows refocusing but demonstrate that it is unlikely that refocusing per se is what causes these improvements. Instead, the characteristics associated with the decision to refocus are associated with improvement in investment efficiency. They estimate treatment effects using both nonparametric (Abadie and Imbens 2006) and parametric (Heckman 1979; Dehejia and Wahba 1999) estimators. Moreover, they find that the observed improvement in investment efficiency is due to measurement error in Tobin’s q rather than to any economically meaningful forces. They replicate Dittmar and Shivdasani’s (2003) analysis and show the inconsistency of their estimates of investment regressions estimated using OLS. This inconsistency stems from the correlation between cash flow in one division and Tobin’s q in another division. They examine the measurement error problem with the third and higher order moment estimators used in Erickson and Whited (2002), and, after accounting for measurement error in q, they find no evidence of improvements in investment efficiency.

4.2.2

Industry-Related Issues

Within this area, there are papers testing the asset liquidity hypothesis and the efficiency explanation. Other relevant studies explore whether economic change and industry shocks might impact the decision to sell assets.

4.2.2.1

Asset Liquidity

There are fundamental factors that motivate divestiture decisions. Given two similar firms, why does one decide to divest a business segment while the other does not and instead opts to restructure it? In the case of divestiture, which is the business segment most likely to be divested? Asset liquidity per se does not give rise to divestitures, but it could play an important role in the process of restructuring, providing an additional perspective on the economic importance of segment liquidity vs. segment performance. The liquidity explanation builds on the focusing and financing explanations, asserting that assets that are relatively more liquid assets are more likely to

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be divested (this is the asset liquidity hypothesis). The liquidity of the market for corporate assets can help to explain why some firms divest assets and others do not, whereas firm characteristics, emphasized by the focusing and the financing explanation of divestitures, cannot capture this difference. Kim (1998) addresses these issues by exploring data from the drilling industry and tests differences in liquidity across four categories of assets. He finds that managers follow a “pecking order” of asset sales and avoid selling illiquid assets unless they face a high cost for alternative source of funds. Moreover, he finds that the liquidity of a firm’s asset portfolio increases its debt capacity. Schlingemann et al. (2002) build on the previous research and empirically show that the relevant factor that triggers the decision to sell assets stems from the liquidity of the asset market of reference, since it determines when to sell the asset as well as the price’s closeness to its fundamental value. The authors empirically prove that the focusing and financing explanations cannot explain why some focusing firms decide to divest and others do not. On the other hand, asset liquidity helps explain whether a given segment is divested or discontinued. Schlingemann et al. (2002) analyze a sample including all focusing US firms over the period 1979–1994; the sample is split into firms that divest segments (divesting firms) and firms that stop reporting segments but do not divest them (discontinuing firms). The second category of firms does not engage in divestiture but more likely only restructuring. Diversified firms that do not focus (i.e., do not stop reporting a segment) and divesting firms are used as control samples. To test their hypothesis, Schlingemann et al. (2002) introduce three measures of liquidity: (1) the industry’s asset market liquidity index; (2) the overall firm’s liquidity index; and (3) the firm’s maximum liquidity index. The first measure aims at comparing liquidity across firms and can help to explain why, among otherwise comparable firms, some divest assets and others do not. The second measure aims at explaining why, among otherwise comparable firms, some firms divest a segment and others do not; this measure allows for a comparison between divesting and discontinuing firms. Finally, the third measure is relevant for detecting which asset a firm wants to sell to raise cash, according to the financing hypothesis. Divesting firms appear to be poor diversifiers, are more financially constrained, and have lower investment opportunities compared to diversified firms. However, divesting firms show no characteristic that is statistically different from the discontinuing firms. The multiple logit regression estimation shows that no firm characteristic is helpful in distinguishing between divesting and discontinuing firms. This evidence highlights that the firm characteristics emphasized by the focusing and financing explanations of divestitures cannot differentiate between these firms. In contrast, the probability that focusing firms will divest a segment increases significantly with liquidity—evidence supportive of the firm liquidity hypothesis. Since liquidity is not a sufficient motive for divestiture, it is not surprising that liquidity is not significant in differentiating between diversified firms and divesting firms. Concerning which segment to sell, Schlingemann et al. (2002) analyze a relative ranking among the different assets characteristics of performance, liquidity, and relatedness relevance in the business. They find that divested segments are smaller,

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are more liquid, and have lower cash flow than other segments in the firm. Moreover, crossing the asset performance with liquidity, they find that the least liquid segment is less likely to be divested than the best-performing segment, while the worstperforming segment is less likely to be divested than the most liquid segment. Crossing the business relatedness with the asset liquidity, they find that segment liquidity is a significant determinant of whether a firm divests core or non-core segments. The higher the maximum core liquidity, the more likely it is that a core segment is divested. The higher the maximum non-core liquidity, the less likely it is that a core segment is divested. The excess value and segment cash flow performance measures have no explanatory power when it comes to accounting for why a firm divests core or non-core segments. These results are inconsistent with the view that firms shed non-core segments because they are poor diversifiers or because the segments underperform their industry. On the contrary, the liquidity of the market for corporate assets can help to explain why, among otherwise comparable firms, some divest assets and others do not. Therefore, asset liquidity can be important for focusing firms that have a choice of which assets to sell. These explanations find their roots in early empirical studies that investigate asset liquidity within specific industries such as the airline, real estate, and oil-drilling industries (e.g., Pulvino 1998; Brown 2000; see also Chap. 5). The explanations can also be traced back to the theoretical paper by Shleifer and Vishny (1992), who show that any distressed firm is forced to sell assets for less than full value to industry outsiders when other industry firms are also experiencing financial constraints (see Chap. 3). These difficulties arise from cash flow shortages and debt overhang.

4.2.2.2

Asset and Firm Productivity Change

The efficiency explanation argues that seller assets, when undervalued by the market as a result of inefficiencies in the operating policies and/or organization structure, might be reallocated to higher-valued uses of potential buyers. If the buyer is motivated to acquire the target’s assets because it foresees potential productivity gains and synergies that can be realized from placing the asset’s current use under its own control, then both buyer and seller might obtain potential gains from such transaction. From the seller’s point of view, if part of the improvement is passed on to the selling firm, the seller’s abnormal return should be higher when the division is sold to a related buyer. It follows that the net sale proceeds will exceed the present value of the net future cash flow from continued ownership and operation, and in this case, the asset sale is in the best interest of shareholders. By using detailed, plant-level data from the Longitudinal Research Database (LRD) compiled by the Census Bureau, Maksimovic and Phillips (2001) track sales of individual plants and benchmark their efficiency against that of other plants in the industry. Their study analyzes (1) the factors associated with the probability that assets transfer ownership and (2) ex ante and ex post changes in productivity for buyers and sellers. Findings related to the first research question show that buyers and sellers are generally large multi-division firms and their probability of selling

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assets decreases with both the asset’s and the segment’s productivity. However, these firms are more likely to sell peripheral divisions than main divisions. This result stems from operational reasons, according to which peripheral divisions are more likely to be dissynergistic. Moreover, Maksimovic and Phillips (2001) find that the probability of selling assets is higher when the selling firm is less productive and a division is more likely to be divested when its expected performance is poorer compared to other divisions. Findings related to the second question show that ex post productivity changes occur for assets transacted and that these productivity changes are associated with buyer and seller initial productivity and firm organization. Overall, these findings suggest that firms have different capacities to exploit assets, with more skilled buying firms being able to transfer skills and improve the assets they purchase. The market for corporate assets facilitates this redeployment of assets from firms with a lower ability to firms with higher ability. Warusawitharana (2008) looks at the determinants of asset sales and tests a model in which asset sales (and purchases) enable the transfer of capital from less productive to more productive firms. These transactions occur as part of the overall investment decisions of value-maximizing firms. In this model, the two main determinants are return on assets and size; these determinants strongly influence a firm’s choice to sell (or purchase) existing assets, with less profitable firms finding it optimal to downsize and sell existing assets. A unit standard deviation decrease in return on assets increases the likelihood of an asset sale by 34%. Moreover, the empirical analysis shows that financing considerations influence firms’ decision to sell assets, with lower levels of liquid assets leading to more asset sales.

4.2.2.3

Industry Shocks

Industry shocks play a crucial role in driving asset sales, given that restructuring is an efficient response to fundamental economic changes. The literature has divided specific industry shocks into internal and external types. Internal shocks include growth, free cash flow, industry concentration, and industry performance (Jensen 1986, 1993). External shocks include changes in technological innovations, changes in government policies such as deregulation and privatization, the impact of foreign competition, and changes in input prices. These ideas are motivated by Coase’s (1937) theory, which argues that firm size responds to changing economic conditions, and by Jensen’s (1993) later work, which relates restructuring activity (of the 1980s) to changes in technology, input prices, and regulation. Mitchell and Mulherin (1996) support this view by finding significant patterns in acquisitions across industries in the 1980s. Their prediction is that takeover and restructuring activity in the 1980s clusters in industries that experience shocks of the greatest magnitude. In the context of asset sales, this result is confirmed by Mulherin and Boone (2000), who find that mergers and divestitures are prevalent in industries undergoing deregulation. This explanation includes the so-called synergistic models that predict that both acquisitions and divestitures create wealth; such models see corporate restructuring as an efficient response to economic shocks, rather than as an imperfect

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reaction to management entrenchment and hubris. Mulherin and Boone (2000) test the predictions of the nonsynergistic and synergistic theories by studying the announcement effects of acquisitions and divestitures of a sample of 1305 firms covering 59 industries in the 1990–1999 period. They find significant industry clustering in acquisition and divestiture activity during the 1990s and argue that acquisition activity, not restricted to industries with limited growth options, is greater in industries undergoing deregulation. They find that both acquisitions and divestitures create wealth and that the two restructuring events are comparable in magnitude. The combined target and bidder announcement return averages +3.5% for acquisitions, while the announcement return for corporate divestitures averages +2.6%. Both of these values, further, are significantly correlated with the relative size of transactions. The symmetric, positive wealth effects for both acquisitions and divestitures are consistent with a synergistic explanation for the two restructuring events but inconsistent with nonsynergistic models based on management entrenchment. As a whole, these results are consistent with the predictions of the synergistic theory that changing economic conditions and industry shocks is at play in restructuring activity. However, Mulherin and Boone (2000) do not examine the correlation between industry shocks and divestiture activity. Using a sample of UK firms over the period 1986–2000, Powell and Yawson (2005) show that broad industry shocks decrease the likelihood of asset sales, while high industry concentration and deregulation increase the likelihood of divestiture activity. Moreover, they show that divestitures cluster across industries, but not over time. Managers frequently blame general industry and economic conditions for the need to downsize. Denis and Shome (2005) examine industry-specific performance, in addition to firm-specific performance, for evidence of problems in the product market. Following Mitchell and Mulherin (1996), they find that firms downsize in response to problems in their product markets at both the firm and industry levels, with reasons related to improvements in firms’ financial circumstances also coming into play. As an additional industry shock, productivity shocks might affect asset purchases and sales. Yang (2008) contributes to the literature by providing new evidence concerning how dynamic properties of productivity shocks may affect asset purchases and sales. Yang (2008) contributes to this strand of the literature by investigating which factors make asset reallocations in one industry more likely than asset reallocations in other industries and why asset sales (and purchases) are procyclical. She finds that changes in productivity brought by shocks are what affect firms’ decisions to buy or sell assets. She also shows that decisions about asset purchases and asset sales are not made in isolation. Rather, a firm makes decisions considering its own investment needs as well as the investment needs of all other firms in the industry. New investments are made when positive aggregate shocks raise the average productivity in the industry, while existing assets are traded when firms’ relative positions change due to firm-specific productivity shocks. Asset sales are used by firms to optimally adjust their capacity given productivity shocks: firms with rising productivity expand and firms with falling productivity downsize.

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Moreover, Yang (2008) shows that asset sales (and purchases) patterns are generated by productivity shocks rather than misvaluation. In fact, by controlling for current valuations, she finds that purchases are more likely when current productivity rises above the long-run mean and asset sales are more likely when current productivity drops below the long-run mean. As a result, buyers may have lower long-run productivity than sellers. The phenomenon of “long-run low buys long-run high” can be caused by productivity shocks rather than misvaluation problems of the sort discussed in previous research (Rhodes-Kropf et al. 2005). In addition, Yang (2008) finds that industries in which firms have less persistent productivity (more frequent changes) and more volatile shocks (bigger changes when they occur) have a higher intensity of asset reallocation. By using plant-level data from the Longitudinal Research Database (LRD) provided by the US Census Bureau over the period 1974–2000, Yang found that after controlling for other industry characteristics, productivity shock properties such as persistence and dispersion explain about 16% of the industry fixed effects in asset sales. Moreover, in expansion years, a 25% decrease in persistence results in a 23% increase in asset sales volume (from +4.31% to +5.28%), and a 25% increase in dispersion leads to an 88% increase in sales volume (from +4.31% to +8.09%). Similar patterns appear in recession years and also with respect to the frequency of transactions. Fixed costs have a negative effect on asset purchases and sales. Higher fixed costs increase the minimum gain requirement for both buyers and sellers and result in fewer sales at higher amounts. Industries with more compatible technology, less specialized assets, and more homogeneous firms (in terms of size) are associated with a higher number of asset purchases and sales.

4.2.3

Conflicts of Interest and Agency Costs

Prior literature offers direct support for this approach. In that literature, governance mechanisms are reported to have a considerable effect on initiating restructuring activities, and hence on the positive value creation, such activities can generate. The approach suggests that, to the extent that agency costs of managerial discretion are important, gains from divestitures should be conditional on the effectiveness of internal mechanisms intended to control agency costs. Thus, although earlier studies (see Sect. 4.2.1) show that divestitures produce small gains on average, these gains should vary cross-sectionally when agency considerations are important. This strand of the literature explains how asset sales can be related to firm characteristics; in particular, it develops the agency explanation for asset purchases (see, for instance, Jensen 1986). Within this area, there are studies investigating the relevance of various corporate governance mechanisms, management’s motivation to sell part of a firm, and the methods of payment used in such transactions.

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4.2.3.1

4 Empirical Perspectives on Asset Sales

Corporate Governance

Several studies investigate the relevance of various corporate governance mechanisms in the context of shareholders’ gains from asset sell-offs. Hirschey and Zaima (1989) look at the insider activity and ownership structure information conveyed to the market in the characterization of sell-off decisions as favorable or unfavorable. Asset sales stock return effects are higher in closely held firms where insiders increase their holdings in the prior 6-month period, confirming other empirical studies that find that executive holdings of common stock, like long-term compensation contracts, work to reduce agency problems related to managerial decisions. Berger and Ofek (1999) establish that various market discipline and incentive-altering events (e.g., management turnover, outside shareholder pressure, management compensation, and financial distress) affect firms’ decision to divest businesses. They examine 107 firms that refocus their operations over the 1985–1993 period and find positive CARs averaged +7.3%. These are significantly related to the amount of the value reduction associated with the refocusing diversification policy. Logistic regressions show that one or more events of outside shareholder pressure or activism by investors increase the probability of refocusing decision activity by between +33.2% and +39.7%, similar to previous results found by Denis et al. (1997). A further determinant of increasing refocusing activity is executive turnover, which increases the likelihood of refocusing by between +7.3% and +19.7%.2 Hanson and Song (2000) also investigate the importance of corporate governance mechanisms in asset sales decisions. Their main hypothesis is that if divestitures resolve or exacerbate agency problems, then the gains to the selling firm should depend on its managerial ownership and board structure. They find stock returns from asset sales announcements are positively related to directors’ share-ownership and to the proportion of outside directors in the divesting firm’s board. By studying a sample of 326 matched buyer and seller pair transactions from 1981 through 1995, where both buyers and sellers are listed companies, Hanson and Song (2000) find that divesting firms receive 3-day excess returns of +0.60%, buyers receive +0.48%, and the value-weighted total return is a marginally significant +0.27%. Dollar excess returns show, interestingly, that on average buyers receive insignificantly more gains than sellers, even though sellers are larger and receive higher percentage gains. Cross-sectional regressions show that when the divestiture creates positive total dollar gains, the divesting firm’s returns are directly and significantly related to managerial ownership, as measured by ownership by officers and directors as a group, by CEO ownership, or by the percentage of unaffiliated outside directors on the board. These results agree with the intuitions, first, that higher levels of ownership give managers the incentive to sell assets that create negative synergies and, in doing so, to negotiate the best price for shareholders and, second, that outside

Berger and Ofek (1999) also find that financial distress does not increase the probability of asset sales.

2

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directors fulfill their responsibilities as effective monitors and advisors to management. Denis and Kruse (2000) examine whether any change in the frequency of three primary disciplinary events that reduce current managers’ control—namely, takeover attempts, shareholder activism, and board dismissals—has changed the way firms address poor performance. They challenge the hypothesis that a decline in the frequency of disciplinary events that reduce the control of current managers could reduce the incentives of managers to maximize firm value—that is, the incentives for them to make value-enhancing restructuring decisions. Considering the dramatic decline in takeover activity in the early 1990s, they test whether it has an impact on either the frequency of control-reducing disciplinary events or the manner in which firms respond to performance declines. They find two main results: (1) asset sales, among other restructuring activities, are more likely in firms facing disciplinary events than in those firms with no disciplinary event;3 and (2) other incentive mechanisms substitute for the takeover market in ensuring that restructuring activities take place following substantial declines in operating performance. Those other mechanisms include the increased use of stock-based compensation, or other forms of managerial monitoring, such as more active boards of directors and more active shareholders. The average abnormal return of restructuring activity announcements over the 2-day announcement period is found to be +0.59% and to be driven by the subsample of asset sale announcements (+1.75%). Overall, besides external disciplinary forces, internal governance mechanisms such as stock-based compensation, an active board of directors, and active shareholders may prompt value-enhancing restructuring, especially through asset sales. Datta et al. (2003) were the first to test the importance of the agency cost of debt in the context of divestitures. Selling assets increases the risk of debt, and managers, subject to lender monitoring, are expected to exercise discipline in the use of cash proceeds. Datta et al. (2003) examine whether private lender monitoring plays a role in divestitures and whether they create value for sellers and acquirers when both stockholders and bondholders are considered. When a firm lacks growth opportunities, effective monitoring of managers is important for shareholders in order to contain free cash flow problems. Likewise, bondholders benefit from asset sales to the extent that wealth transfer to shareholders is minimized in the presence of monitoring. For the divesting firm, the level of monitoring is expected to be positively related to the abnormal stock and bond market reaction to the asset sale announcement. Collectively, the analysis shows that well-managed and highly monitored firms are more likely to benefit from asset sale transactions. They document that both stock and bond excess returns for divesting firms are significantly positively related to monitoring by private creditors, thereby providing support for the notion that effective monitoring enhances firm value in asset sale transactions. In bidder firms, by contrast, only stockholders benefit significantly

3 Denis and Kruse (2000) consider the following as restructuring activities: asset sales, asset reorganizations, and layoffs or cost-cuttings.

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from lender monitoring. In short, private monitoring, along with managerial performance, are important determinants of both stockholder and bondholder wealth surrounding corporate asset sales announcements. These results can be explained in the framework of Jensen’s (1986) free cash flow hypothesis, whereby wellmanaged and highly monitored firms are more likely to create transactional value in corporate asset sales. Owen et al. (2010) analyze the role of corporate governance in pressuring managers to make efficient firm scope decisions. Once the firm has established fundamental reasons to divest a division, in order to overcome managers’ reluctance to shrink firm size and reduce their private benefits from controlling a larger firm, good corporate governance must be in place to observe more efficient restructuring decisions. Owen et al.’s (2010) results confirm that sell-off announcement stock returns are related to measures of better corporate governance. Using a sample of 797 completed US divestitures during the period 1997–2005, they observe that divestitures produce an average announcement (3-day) abnormal return of +1.57%, representing a substantial average dollar amount of US$85.46m (in 2005 dollars). To proxy for governance quality, they use indices representing strength of shareholder rights and management. Although they do not find support for a negative relationship between governance indices and divestiture abnormal returns, their results suggest that firms with more effective corporate governance have a greater probability of engaging in divestitures. Specifically, stronger shareholder rights and significant management ownership increase the probability of a divestiture. Operating in a highly competitive market also increases the probability of a divestiture. This result is consistent with a well-known idea in corporate finance, namely, that both industry effects and governance mechanisms complement one another to produce higher shareholder wealth from asset restructuring. Kang et al. (2010) study corporate governance effects in restructuring activity during times of an economic shock. When an economic shock hits firms, shareholders and debtholders react differently to restructuring decisions, because of their divergent interests and incentives. Agency costs exacerbate these differences in decisions about how to handle the crisis, and corporate governance might have a relevant role in corporate restructuring. As a natural experiment for testing their hypotheses, Kang et al. (2010) sample restructuring transactions completed by Korean chaebol firms (i.e., conglomerates) during periods of economic downturn. Empirical results show an abnormally higher frequency of restructuring compared to restructuring activities during periods of performance decline. The frequency of cash-generating restructuring actions is higher for firms in the economic shock sample than for firms in the performance decline sample, suggesting that firms experiencing an economic shock have stronger incentives to choose restructuring that mitigates their liquidity constraints than firms experiencing performance declines do. During an economic shock, chaebol firms that engage in (cash-generating) restructuring actions realize a positive and significant announcement return, whereas during a performance decline, both chaebol firms and non-chaebol firms experience insignificant stock return effects. The cross-sectional regression analysis focuses on

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the relationship between announcement effects and variables that relate to agency costs. Kang et al.’s (2010) study shows that the likelihood of restructuring is negatively related to the divergence of cash flow rights and control rights of controlling shareholders and that the announcements of restructuring by the chaebol firms with such divergence are greeted more negatively by investors. However, firmspecific measures of corporate governance such as total debt, bank loans, and equity ownership by claimholders such as financial institutions mitigate these negative effects, thereby influencing firms to choose value-maximizing restructuring policies.

4.2.3.2

Management Performance and Compensation Structure

A key question in empirical research on asset sales is how to motivate managers to reduce firm size. Theoretical models assume that divestitures are undertaken to benefit stockholders’ interest. However, sell-offs can also be motivated by managerial self-interest, particularly when sell-offs generate an increase in profitability and indirectly an increase in management compensation. Asset sales can be viewed as investment decisions motivated by incentive compensation contracts available to managers of the divesting firm. So far, there is no theory about what kinds of companies adopt what types of compensation plans or about how these plans affect sell-off decisions. The interests of management and stockholders may potentially diverge when the firm is making investment decisions. In this context, a source of conflict addressed in the literature is the horizon problem. Given the typical management compensation contract, managers tend to focus on short-term profits, which may harm long-term performance. Since all (or part of) manager’s remuneration is contingent on short-term performance, managers become quick-profit oriented and tempted to dispose of assets that generate a short-term profit regardless of their longterm potential. Tehranian et al. (1987) find that divesting firms with manager compensation plans featuring a longer-term orientation experience higher asset sale announcement effects than firms not adopting those manager pay packages. The CARs for event period t 1 to t+1 are +0.88% and +0.61% for firms with long-term performance plans and firms without long-term performance plans, respectively. These results are consistent with the hypothesis that long-term compensation plans motivate managers to make better sell-off decisions and that firms employing long-term compensation plans are viewed by the market as better aligned with stockholder interests. Huang (2014) investigates how managerial expertise—especially industry expertise—affects firm value through divestiture, finding that CEOs in diversified conglomerates are more likely to divest divisions in industries in which they have less experience. This finding is consistent with the behavior of CEOs who divest such divisions in order to refocus on those divisions in which they have specialized—that is, to achieve a better match between their expertise and their firms’ retained assets. Firms that divest for a better CEO firm match experience significant improvements in operating performance, as well as significant abnormal stock returns that persist for an average of 3 years following a divestiture. Further, among firms that divest for

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4 Empirical Perspectives on Asset Sales

a better match, those firms with more experienced CEOs realize greater gains in firm value. In contrast, divestitures that increase corporate focus, but do not improve the expertise-asset match, do not lead to long-run increases in firm value. Chiu et al. (2016) find that CEO successors hired inside the firm vs. from the outside managerial market have distinct effects when restructuring firms. They demonstrate that new inside CEOs are associated with a greater scale of divestitures, whereas new outside CEOs are associated with a greater scope change through divestiture. These findings confirm Boot’s (1992) prediction that managers who engage in divestitures are more capable, because they realize the impact that restructuring plans could have on maximizing firms’ value. Humphery-Jenner et al. (2019), for their part, show that firm-level divestiture experience is an important factor for divestiture performance. They demonstrate that that driver is more important in comparison to CEO characteristics, board divestiture experience, and other restructuring experience proxies. Accumulated experience in divesting assets translates into a greater likelihood to focus on selling peripheral or underperforming units and to time the restructuring appropriately by divesting when market liquidity is higher—e.g., during an industry merger cycle. Moreover, these divestitures have higher announcement return effects and stronger post-divestiture operating performance, and they tend to reinvest sale proceeds in expansion programs via acquisitions.

4.2.3.3

Methods of Payment

It is a well-known stylized fact in corporate finance that outside equity is underpriced because of joint effects of information asymmetries and adverse selection costs (Myers and Majluf 1984). Any attempt to issue new equity capital leads to a reduction in firm value. Classical examples are initial public offerings (IPOs) and seasoned equity offerings (SEOs). The same logic applies when equity is prevalent as a mean of payment in mergers and acquisitions. However, when asset sales are considered with equity as partial or total payment, the seller does not retain any residual interest in the divested asset but instead definitively sells the asset in return for an equity interest in the buyer firm. It follows that both parties, pursuant to the business judgment rule, agree to establish the seller as a corporate blockholder vis-à-vis the buyer. Thus, an asset-for-equity sale generates a corporate blockholding in the buyer firm that can affect managerial incentives for value creation. In this regard, alternative predictions have been proposed in the more general framework for studying payment methods; differences between the predictions turn on whether blockholders enhance value for dispersed shareholders because of their monitoring activities4 or rather reduce value by fostering managerial entrenchment.5

4

See Holmström and Tirole (1993) and Burkart et al. (1997). See DeAngelo and Rice (1983), Jensen (1986), Shleifer and Vishny (1989), and Jensen and Murphy (1990). 5

4.2 Empirical Research on the Efficiency Theory of Asset Sales

51

Slovin et al. (2005) investigate whether buyer equity is an effective consideration when contracting in intercorporate asset markets and whether it may even affect buyer openness to the market for corporate control. Their study shows that equity payment exerts positive stock returns effects in the corporate asset market. Their empirical analysis focuses on the use of buyer equity as the means of payment in intercorporate asset sales and compares the results to cash asset sales. The main finding is that the use of buyer equity to purchase operating assets generates significantly larger combined gains in wealth than cash asset sales, and these gains are shared between buyers and sellers. In contrast, in cash asset sales, all of the (proportionately smaller) gains go to sellers. Slovin et al. (2005) find that these transactions, i.e., asset-for-equity sales, generate large and significant increases in firm value of about +10% for buyers and +3% for sellers. By comparison, cash asset sales generate non-significant returns to buyers and significant returns of +1.9% to sellers. Moreover, gains in wealth created by asset-for-equity sales are significantly greater relative to transaction size than gains created by cash asset sales; these higher gains further strengthen efficiency improvements. This pattern of larger gains being associated with asset-for-equity sales is in contrast with patterns for mergers and takeovers of public firms, in which, as discussed in the literature, equity is an unfavorable signal of buyer value. Moreover, for events in which equity payments to sellers constitute less than 5% of buyer outstanding shares, the average excess return to buyers is large (+9%) and highly significant. This result suggests that it is the use of equity as a means of payment, and not simply the formation of a corporate blockholding, that is an important factor enhancing buyer market value. Hege et al. (2009) complement the empirical evidence from Slovin et al. (2005), suggesting that equity-based asset sales, which create corporate blockholders, generate more favorable share price effects than cash sales. Specifically, Hege et al. (2009) provide new empirical evidence investigating a sample of asset sale transactions where relevant shares of buyer stocks are not paid to the selling firm and instead are conveyed directly to its shareholders, ensuring that the seller does not become a corporate blockholder in the buyer. This sample design allows for more definitive conclusions about the favorable signal content of the transfer of assets through equity-based transactions, given that the sample used excludes events that result in the formation of corporate blockholdings. Hege et al. (2009) find that equity-based asset sales contribute to economic value because they convey positive information about the value of the asset being sold, as well as positive expectations of heightened future profitability from the buyer’s use of the asset. Equity-based sales generate significant average excess returns of +6.9% for sellers and +3.4% for buyers and combined gains of +4.2%. For cash sales, seller returns are smaller, at +1.4%; furthermore, buyer returns and combined gains are not significant. The evidence indicates that, on average, the gains in value from cash asset sales accrue solely to sellers. The estimation results for a logit model of the choice of the means of payment indicate that the only asymmetric information about the seller, and not about the buyer, influences the choice of equity versus cash in intercorporate asset sales. Moreover, significant improvements occur in the subsequent operating performance of buyers in equity-based deals, whereas there are no changes in

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performance after cash deals. Overall, selling firms establish a structure for intercorporate asset sales that ensures the informational efficiency of these transactions.

4.3

Empirical Research on the Financing Theory of Asset Sales

Asset sales can also be an alternative source of external financing. Asset-sale proceeds can be used to fund corporate investments. In fact, firms could be in a position to meet their financing needs through issuing securities, yet still choose to sell assets. Hite et al. (1987) examine the stated motives for asset sales and note that “in several cases selling assets was viewed as an alternative to the sale of new securities.” On the one hand, asset sales are a source of funds like security issuance and should be considered alongside security issuance in a financing decision. On the other hand, unlike security issuance, asset sales can have real effects by reallocating physical resources and changing firms’ boundaries. Both sellers and acquirers of assets generally gain from the improved allocation of resources following divestitures (Sicherman and Pettway 1992). However, asset sales place funds at the discretion of the selling firm’s management, which may use the proceeds to destroy value. The empirical evidence related to asset-sale proceeds refers to the financing theory. As we did with the efficiency theory, we identify three streams of research in this area as well, which again deal with different market frictions: information asymmetries, firms’ financial constraints, and conflicts of interest and agency costs. Table 4.2 summarizes the main results of this empirical literature.

4.3.1

Information Asymmetries

Lang et al. (1995) show that the reinvestment of asset-sale proceeds for expansion through acquisitions destroys shareholder value but report value gains for sellers who pay out the proceeds to bondholders (repaying debt) and shareholders (increasing dividends or repurchasing shares). Markets assume that if asset-sale proceeds are left under management control, those funds are more likely to be reinvested in negative net present value investments. Asset sales are common corporate events that frequently result in a substantial increase in the level of discretionary funds at the disposal of divesting managers. From a shareholder perspective, the existing literature suggests countervailing costs and benefits associated with the retention of sale proceeds for subsequent investment. From an efficiency perspective, retained proceeds allow the firm to bypass capital markets’ adverse selection when it comes to financing any remaining positive NPV projects. Alternatively, if management’s

Financial constraints

1980– 1999

1998– 2009

1980– 2008

Borisova et al. (2013)

Borisova and Brown (2013)

1971– 2016

Hovakimian and Titman (2006)

Desai and Gupta (2019)

Financing theory Information Lang et al. asymmetries (1995)

Time period 1984– 1989

USA

USA

USA

USA

Country USA

3156

294 crossborder; 1164 domestic

1474

2403

Sample size 93 whole sample; 40 payout sample; 53 reinvest sample

Table 4.2 Summary findings related to the financing theory

3.18% cross-border; 1.72% domestic

Seller 1.41% whole sample; 3.92% payout sample; 0.48% reinvest sample

CARs

1.88% crossborder; 1.84% domestic

Buyer

[ 1;+1]

Event window [ 1;0]

GMM regressions Endogenous switching regression models

Endogenous switching regression models with unknown sample separation Linear regressions

Logistic regressions

Econometric methods Linear regressions

R&D spending

CAR

Categorical variable if assets are bought, equity is issued, debt is issued, or do nothing Capital expenditure

Dependent variable CAR

(continued)

Cross-border asset sales Binary variable for negative income Binary variable for interest coverage ratio Cash proceeds from the sale of property, plant, and equipment

Cash from asset sales Cash flow
financial slack

Firm’s size of financing need

Main explanatory variables Payout proceeds

4.3 Empirical Research on the Financing Theory of Asset Sales 53

1992– 1995

1990– 2004

Financing theory Corporate Bates (2005) governance

Ataullah et al. (2010)

Clayton and Reisel (2013)

USA

UK

Country USA

Note: “nss” stands for not statistically significant

Time period 1990– 1998

Table 4.2 (continued)

439

Sample size 372 whole sample; 156 retention sample; 176 debt payout sample; 40 equity payout sample 195 whole sample; 74 retention sample; 29 shareholder distribution sample; 92 debt repayment sample

0.99% shareholders; 0.23% bondholders

Seller 1.2% whole sample; 0.9% retention sample; 1.6% debt payout sample; nss. equity payout sample 2% whole sample; 0.9% retention sample; 2.4% shareholder distribution sample; 3.8% debt repayment sample

CARs Buyer

Event window

Bond excess returns Equity excess returns

Categorical variable if sales proceeds are retained, distributed to equity, or distributed to bond

Logistic regressions

Linear regressions

CAR

Dependent variable Categorical variable if sales proceeds are retained, distributed to equity, or distributed to bond

Linear regressions

Econometric methods Logistic regressions

Executive share-ownership Executive options Large institutional shareholdings Executive share-ownership Executive options Large institutional shareholdings Leverage Debt payout Equity payout

Main explanatory variables Capital expenditure

54 4 Empirical Perspectives on Asset Sales

4.3 Empirical Research on the Financing Theory of Asset Sales

55

personal incentives are unconstrained, any financing benefits are likely to be subsumed by the agency costs of managerial discretion. Desai and Gupta (2019) were the first to carry out an empirical investigation of the financing choice firms make between asset sales and security issuances. They analyze the effect of investment need on a firm’s choice of internal versus external financing. Their empirical design is inspired by the model proposed by Edmans and Mann (2019) (see Chap. 3). Their results show that the likelihood of a security issuance versus an asset sale increases with the size of financing need, supporting the prediction of the balance sheet effect. Moreover, they observe that firms switch from an asset sale to an equity issue at a much higher level of financing need than they do for a debt issuance.

4.3.2

Financial Constraints

Voluntary divestitures might provide an important financing source for financially constrained firms, but not for financially unconstrained firms. Hovakimian and Titman’s (2006) findings confirm that hypothesis showing that cash obtained from asset sales is a significant determinant of corporate investment and that the sensitivity of investments to proceeds from asset sales is significantly stronger for firms that are likely to be financially constrained. Therefore, financial constraints partially explain why firms invest more when they sell assets: they are more likely to use asset-sale proceeds as leverage. On the other hand, lower sensitivity of investment to asset sales and internal funds is found in firms with characteristics that separate them from financially constrained firms—that is, firms that are larger, are older, have lower market-to-book ratios, have lower levels of financial slack, have rated bonds, and are more likely to pay dividends. Borisova and Brown (2013) consider whether firms use asset-sale proceeds to support intangible investments, a class of investments that are particularly susceptible to financing difficulties. They build on Hovakimian and Titman’s (2006) insight that a fixed investment response to asset-sale proceeds provides relatively clean evidence of financing frictions, because asset-sale proceeds (unlike cash flow and other financial variables) are not positively associated with investment opportunities. However, they argue that examining the link between asset-sale proceeds and intangible investment offers an even stronger test of financing constraints, because there is no obvious alternative to a financing channel that connects fixed asset sales and corporate R&D investment. Although funding from divestitures is necessarily limited, the use of cash inflows from asset sales for intangible investments can be valuable because asset sales tend to be negatively correlated with other financing sources and because the information problems that plague R&D-intensive firms need not affect the property they choose to sell (Shleifer and Vishny 1992). This suggests that divestitures may be especially valuable to innovative firms during recessions and other periods when liquidity constraints would otherwise limit their growth

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opportunities. Borisova and Brown (2013) show that funds from the sale of fixed assets can support intangible investment in firms facing binding financial constraints. Borisova et al. (2013) empirically test asset sales as a source of financing used by liquidity-constrained firms to rebalance their capital structure. When a macroeconomic recession hits, divestitures can represent an alternative fund-raising channel for firms without access to capital markets. However, the recession could also increase liquidity needs of local industry buyers and prevent them from purchasing assets for sale. Borisova et al. (2013) investigate whether foreign buyers enter into a country’s corporate asset market to provide wealth-generating injections of capital for domestic divesting firms. Using a comprehensive sample of 294 asset sales initiated by US firms which involved foreign buyers from 29 countries over the period of 1998–2008, they document higher abnormal seller returns for cross-border sales than for a sample of 1164 asset transfers occurring between US firms. Seller returns in cross-border sales average +3.18% over a 3-day event window, while domestic sellers average returns of +1.72% over the same period. This incremental return is driven by liquidity-seeking sellers. Overall, Borisova et al.’s (2013) results highlight the financing role of divestitures and also how the market recognizes foreign buyers as a valuable source of funds, particularly for financially constrained domestic sellers seeking liquidity.

4.3.3

Corporate Governance

In this area, empirical studies have been exploring the question of whether positive reaction to divestiture decisions could be related to good governance mechanisms that foster the alignment of shareholders’ and managers’ interests. Better governance, as discussed previously, deters the misallocation of sell-off proceeds. Indeed, Bates (2005) finds that the likelihood of a distribution of sell-off proceeds, relative to the retention, increases with directors’ share-ownership. Utilizing data from 400 large cash transactions between 1990 and 1998, Bates (2005) examines the role of growth opportunities and capital expenditures in relation to the allocation of sale proceeds between the firm and its claimants, as well as cross-sectional variations in shareholder returns from these allocation decisions. The average announcement period CAR for the sample is +1.2% over a 3-day interval around the day of the sale announcement. In line with previous research, CARs vary significantly with the reported use of proceeds: average CARs to firms retaining proceeds are 0.9% significantly lower than the +1.6% return to firms announcing a distribution of proceeds to debt claimants. However, abnormal returns from retention decisions are statistically indistinguishable from the average +0.7% CAR observed for sale announcements and equity distributions. The difference in the average announcement return to debt and equity distributions is +0.9% and is statistically significant at 10%, indicating that, on average, stock markets react more favorably when asset-sale proceeds are used to repay debt. Moreover, Bates (2005) finds that retention probabilities tend to increase in the divesting firm’s contemporaneous growth

4.3 Empirical Research on the Financing Theory of Asset Sales

57

opportunities and expected investment. Retaining firms, however, also systematically overinvest relative to an industry benchmark. Shareholder returns from retention decisions are positively correlated with growth opportunities and benchmarked investment but negatively correlated with benchmarked investment for firms with poor growth opportunities. Announcement returns when asset-sale proceeds are used to repay debt produce an increase in industry-benchmarked leverage, indicating the positive view of deleveraging asset sale decisions. Overall, Bates’ (2005) findings are consistent with the hypothesized trade-off between the investment efficiencies associated with retained sale proceeds and the agency costs of managerial discretion and debt. Ataullah et al. (2010) investigate how corporate governance influences the allocation of sell-off proceeds. They consider as potential variables directors’ share-ownership and stock options, board composition, and the presence of large shareholders (institutional and non-institutional). Their study is based on a sample of UK public firms’ asset sales in the period from 1992 to 2005. The average 3-day CARs for the entire sample are around +2%; for the retention sample, they are around +0.9%. However, the 3-day CARs for the debt repayment sample and the equity distribution sample are +3.8% and 2.4%, respectively. Results suggest that corporate governance mechanisms are related to shareholders’ gains for divesting firms that retain sell-off proceeds but not for firms that distribute proceeds. In particular, non-executive directors’ and CEOs’ shareownership and stock options are positively related to shareholders’ gains from sell-offs for firms that retain proceeds. Moreover, the likelihood of a distribution of sell-off proceeds relative to the retention decision increases with large institutional shareholdings. However, large non-institutional shareholdings do not influence the allocation of sell-off proceeds. CEOs’ stock options negatively influence a distribution of proceeds to shareholders. Lastly, the likelihood of a distribution of sell-off proceeds increases with the share-ownership of executive and non-executive directors and with the proportion of non-executive directors in the board. Asset sales undertaken by highly leveraged firms can exert positive effects when deleveraging capital structure. This research question is motivated by the observation that asset sales may be an efficient mechanism to restore financial flexibility and increase firm value.6 Clayton and Reisel (2013) examine (1) whether firms use asset sales to undertake capital structure change and (2) whether this accounts for value creation for shareholders and bondholders. Consistent with extant empirical research, they find positive announcement excess stock returns (+0.99%). They also find positive and significant mean bond portfolio return (+0.23%), suggesting that asset sales also create value for debtholders. Both excess stock and bond returns are concentrated in firms with high leverage and which use asset-sale proceeds to repay debt. These factors remain significant determinants of excess returns for both bonds and stocks after controlling for other factors that may create value, such as increase in focus, debt covenant structure, managerial ownership structure, and firm 6

See, for example, Almeida et al. (2011) and Denis (2011).

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4 Empirical Perspectives on Asset Sales

characteristics. These results also remain robust even when the consideration that the use of proceeds is unlikely to be assigned randomly across firms, but rather is endogenously determined as a function of firm characteristics, is taken into account.

4.4

Asset Sales in Banking

Asset sales in banking involve the sales of either financial assets or real assets. Banks are highly regulated, so their motivation to sell assets goes beyond the determinants we have reviewed for a typical nonfinancial firm. The most traded assets by banks are loans. The emergence of the loan sale market is a response to the segmented nature of bank loans, which stems from the differential regulatory costs and lending opportunities faced by financial intermediaries. Banks might sell loans to other banks and nonbank financial institutions in the secondary loan sales market. Loan selling is separate from loan origination, serving, monitoring, and funding, and this disengagement creates frictions among sellers and buyers as well as nonfinancial borrowers. A bank may sell loans because it has a comparative advantage in booking certain types of loans and can use loan sales to fund originations of similar loans, possibly achieving economies of scale. For example, a bank may have expertise in a specific industry and granting loans to firms in that economic sector. That will increase the quality of the average loan and justify lower monitoring costs. Consequently, banks sell loans to buyers that have relatively cheap funding sources but poor loanoriginating opportunities (the comparative advantage hypothesis). Also, loan sales may facilitate gap management and enhance diversification. A bank may want to diversify its loans in order to reduce their monitoring costs and avoid the wrath of disappointed shareholders, or it may sell certain types of loans in order to fund other portions of its portfolio, rather than try to attract more retail deposits or purchase funds. This hypothesis predicts that banks with limited opportunities to originate loans and diversify their portfolios (attributable to size constraints or limitations in their geographic expansion) are most likely to participate in the secondary bank loan market (the diversification hypothesis). These banks are likely to participate in both the buying and selling sides of the market, because they are not using the secondary market to facilitate growth or shrinkage of their loan portfolio. Rather, they use loan sales and purchases to rebalance a portfolio of a given size. Asset sales may allow a bank to avoid “regulatory taxes” and save on the regulatory costs of on-balance sheet funding, including minimum reserve requirements, minimum capital requirements, and the cost of deposits insurance. On the one hand, banks have a comparative advantage in originating loans but a disadvantage in warehousing low-risk loans, due to regulatory taxes that banks must pay in the form of federal deposit insurance premiums, foregone interest from holding required reserves, and mandatory capital requirements that exceed those that would be maintained in the absence of regulation. Banks may sell loans in order to become

4.4 Asset Sales in Banking

59

like investment banks, underwriting loans but not warehousing them. A bank can sell loans all the time, sometimes, or never. The first empirical studies in this area investigate the motivations for loan sales activity and in particular the sale of commercial and industrial loans (Pavel and Phillis 1987; Berger and Udell 1993; Demsetz 1994; Haubrich and Thomson 1996). Their results appear to support the comparative advantage hypothesis and show that banks with low capital and high funding costs are more active loan sellers. Demsetz (1994) also finds that proxies for local origination opportunities positively affect sales volume. However, Haubrich and Thomson (1996) find that capital is negatively related to loan purchase activity, which is the opposite of what the comparative advantage story predicts. Regarding the diversification hypothesis, Pavel and Phillis (1987) and Berger and Udell (1993) confirm the sales activity is motivated by a need to diversify banks’ loan portfolio. However, bank risk is generally not related to sale activity; this suggests that riskier banks are not excluded from the loan sales market. Demsetz (2000) extends previous literature by testing the two hypotheses considering banks as simultaneously being seller and buyer. Consistent with the comparative advantage hypothesis, banks with ample loan-originating opportunities have a higher likelihood of being on the selling side, and banks with greater funding capacity have a higher likelihood of being on the buying side. Consistent with the diversification hypothesis, the likelihood of both sales and purchases increases with limitations on statewide branching and interstate expansion, since these limitations typically restrict opportunities for diversified originations. Güner (2006) analyzes the economics of loan sales from the borrowing perspective. Although the bank has strong incentives to fund a loan by selling it (Pennacchi 1988), borrowers may not benefit from the bank’s reduced lending costs, because loan markets are segmented and less than perfectly competitive. Güner (2006) finds that the average yield spread of loans originated by active loan sellers is about 20 basis points lower than the average spread on loans originated by moderate loan sellers. Drucker and Puri (2009) investigate the mechanisms (i.e., loan contract design) to reduce the informational and agency problems in loan sales. Selling assets involve the separation of loan origination from servicing and funding, and this separation can introduce agency and informational problems that place significant limitations on loan selling. New lenders that buy loans are likely to have less borrower-specific information and less ability to monitor the borrower. Moreover, loan selling introduces an agency problem between buyers and sellers, because lenders have less incentive to screen and keep monitoring borrowers after they shed loan credit risk. Lenders also have an incentive to sell loans that they privately know are likely to perform poorly. The separation of the lending functions allows new funds to flow into the loan markets that may alter the relationship between borrower and lender. Drucker and Puri (2009) find that divested loans contain additional covenants and more restrictive net worth covenants, particularly when agency and informational problems are more severe. However, borrowers agree to incur the additional costs associated with loan sales. They might benefit through increased private debt availability, since the vast majority of loan buyers are

60

4 Empirical Perspectives on Asset Sales

nonbank institutions that generally do not originate loans but can provide additional funding to borrowers. Irani and Meisenzahl (2017) examine how banks use loan sales to manage liquidity during periods of market stress and the associated spillovers to market prices. Using a US credit register of syndicated loans, they relate banks’ decisions to change the level of their loan ownership during a crisis to their funding mix. They show that banks with a greater reliance on wholesale funding attempt to smooth out funding disruptions via loan sales, while banks with adequate liquidity (i.e., stable, long-term funding or holdings of liquid assets for a given level of wholesale funding) are less likely to sell loans shares during the crisis. This trading activity has a negative spillover to secondary market price, since liquidity-strained banks are selling loans at discount, as compared with loans held by banks with more stable funding. This evidence suggests that liquidity regulation that either reduces exposure to non-core funding or requires liquid-asset holdings may have the benefit of limiting destructive fire sales during bad times. Beyhaghi et al. (2017) investigate the conditions under which a bank might use loan sales rather than credit default swaps (CDS) or use sales to lay off or hedge all or part of its credit risk exposure in a certain loan. Purchasing credit derivatives and making loan sales have different implications for a bank in terms of (1) maintaining control rights, (2) providing incentives to continue monitoring the borrower, (3) the bank’s overall reputation, (4) its future lending relationships, (5) its cost and revenue generation, and (6) the effects on its overall capital and liquidity, many of which have been overlooked. Beyhaghi et al. (2017) show that banks are more likely to use a credit risk transfer (CRT) instrument rather than hold (unhedged) loans on their balance sheets when they are facing capital and liquidity constraints. In addition, if banks decide to use a CRT instrument, they are more likely to sell loans when loans have been made to ex ante low-quality borrowers and use CDS when loans have been made to ex ante high-quality borrowers, similar to the predictions of the model developed by Parlour and Winton (2013) (see Chap. 3). Additionally, banks are more likely to keep loans on their balance sheets if they have an ongoing relationship with a borrower and to use a CRT instrument for transactional borrowers. From a regulatory point of view, if a bank is viewed as an extensive seller of its loans, it indicates that it is capital and liquidity-constrained and/or making high-risk loans. Thus, the volume of loan sales may be viewed as a signal of bank risk exposure for bank examiners and regulators. Curi and Murgia (2018) study asset sales in banking from another angle. They investigate a sample of the world’s largest financial conglomerates from 15 countries and track their largest divestitures over the period 2005–2016. They consider all types of sales: loan sales, sales of non-traditional activities, and real assets. They test the typical hypotheses discussed for nonfinancial firms (the corporate focus and efficiency explanation, the asset liquidity hypothesis) and aim to assess whether asset sales in financial conglomerates contribute to a reduced conglomerate discount measure. Their evidence supports the divestiture market impact having a significant effect on conglomerate excess value. In particular, most of the positive impact of divestiture programs originates from disposing of financial sector assets. However,

References

61

only investment banking asset sales exert positive impact on income-based excess value. Asset sales outside the financial sector have no meaningful impact on conglomerate market value, undermining the focus view with respect to financial firms. When Curi and Murgia (2018) examine financial conglomerates restructuring during crises, a different picture emerges. As the value of conglomerate diversification shifts from negative (discount) to positive (premium), undertaking investment banking asset sales has a reduced impact on conglomerate market impact from the income-based perspective. However, commercial banking asset sales exert a positive impact on asset-based excess value. Commercial banking activities represent a higher proportion of the conglomerate risk-weighted assets than investment banking lines of business. Thus, divesting commercial banking assets liberates equity capital that may contribute to the positive effect on market valuation, particularly during periods of financial crisis. Manz et al. (2019) examine financing cost implications of non-performing loans (NPL) divestitures in the European industry, where active portfolio reduction, i.e., selling NPL as single loans, loan baskets, or in larger portfolios to the secondary market, has become increasingly popular. European regulators consider NPL a top priority and require banks to develop effective restructuring strategies to reduce their NLP exposure. Manz et al. (2019) find that European banks are not able to reduce their financing costs in the debt market, casting doubts about the long-run effectiveness of NPL sales.

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Brown DT (2000) Liquidity and liquidation: evidence from real estate investment trusts. J Financ 55 (1):469–485 Burkart M, Gromb D, Panunzi F (1997) Large shareholders, monitoring, and the value of the firm. Q J Econ 112(3):693–728 Chiu S-C, Johnson RA, Hoskisson RE, Pathak S (2016) The impact of CEO successor origin on corporate divestiture scale and scope change. Leadersh Q 27(4):617–633 Clayton MJ, Reisel N (2013) Value creation from asset sales: new evidence from bond and stock markets. J Corp Financ 22:1–15 Coase RH (1937) The nature of the firm. Economica 4(16):386–405 Çolak G, Whited TM (2006) Spin-offs, divestitures, and conglomerate investment. Rev Financ Stud 20(3):557–595 Comment R, Jarrell GA (1995) Corporate focus and stock returns. J Financ Econ 37(1):67–87 Curi C, Murgia M (2018) Divestitures and the financial conglomerate excess value. J Financ Stab 36:187–207 Datta S, Iskandar-Datta M, Raman K (2003) Value creation in corporate asset sales: the role of managerial performance and lender monitoring. J Bank Financ 27(2):351–375 DeAngelo H, Rice EM (1983) Antitakeover charter amendments and stockholder wealth. J Financ Econ 11(1-4):329–359 Dehejia RH, Wahba S (1999) Causal effects in nonexperimental studies: reevaluating the evaluation of training programs. J Am Stat Assoc 94(448):1053–1062 Demsetz R (1994) Evidence on the relationship between regional economic conditions and loan sales activity. Proceedings of the 30th Annual Conference on Bank Structure and Competition, pp 370–380 Demsetz RS (2000) Bank loan sales: a new look at the motivations for secondary market activity. J Financ Res 23(2):197–222 Denis DJ (2011) Financial flexibility and corporate liquidity. J Corp Financ 17(3):667–674 Denis DJ, Kruse TA (2000) Managerial discipline and corporate restructuring following performance declines. J Financ Econ 55(3):391–424 Denis DK, Shome DK (2005) An empirical investigation of corporate asset downsizing. J Corp Financ 11(3):427–448 Denis DJ, Denis DK, Sarin A (1997) Agency problems, equity ownership, and corporate diversification. J Financ 52(1):135–160 Desai CA, Gupta M (2019) Size of financing need and the choice between asset sales and security issuances. Financ Manag 48(2):677–718 Dittmar A, Shivdasani A (2003) Divestitures and divisional investment policies. J Financ 58 (6):2711–2744 Drucker S, Puri M (2009) On loan sales, loan contracting, and lending relationships. Rev Financ Stud 22(7):2835–2872 Edmans A, Mann W (2019) Financing through asset sales. Manag Sci 65(7):3043–3060 Erickson T, Whited TM (2002) Two-step GMM estimation of the errors-in-variables model using high-order moments. Economet Theory 18(3):776–799 Güner AB (2006) Loan sales and the cost of corporate borrowing. Rev Financ Stud 19(2):687–716 Hanson RC, Song MH (2000) Managerial ownership, board structure, and the division of gains in divestitures. J Corp Financ 6(1):55–70 Haubrich JG, Thomson JB (1996) Loan sales, implicit contracts, and bank structure. Rev Quant Finan Acc 7(2):137–162 Heckman JJ (1979) Sample selection bias as a specification error. Econometrica 47(1):153–161 Hege U, Lovo S, Slovin MB, Sushka ME (2009) Equity and cash in intercorporate asset sales: theory and evidence. Rev Financ Stud 22(2):681–714 Hirschey M, Zaima JK (1989) Insider trading, ownership structure, and the market assessment of corporate sell-offs. J Financ 44(4):971–980 Hite GL, Owers JE, Rogers RC (1987) The market for interfirm asset sales: partial sell-offs and total liquidations. J Financ Econ 18(2):229–252

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Holmström B, Tirole J (1993) Market liquidity and performance monitoring. J Polit Econ 101 (4):678–709 Hovakimian G, Titman S (2006) Corporate investment with financial constraints: sensitivity of investment to funds from voluntary asset sales. J Money Credit Bank 38(2):357–374 Huang S (2014) Managerial expertise, corporate decisions and firm value: evidence from corporate refocusing. J Financ Intermed 23(3):348–375 Humphery-Jenner M, Powell R, Zhang EJ (2019) Practice makes progress: evidence from divestitures. J Bank Financ 105:1–19 Irani RM, Meisenzahl RR (2017) Loan sales and bank liquidity management: evidence from a US credit register. Rev Financ Stud 30(10):3455–3501 Jain PC (1985) The effect of voluntary sell-off announcements on shareholder wealth. J Financ 40 (1):209–224 Jensen MC (1986) Agency cost of free cash flow, corporate finance, and takeovers. Am Econ Rev 76(2):323–329 Jensen MC (1993) The modern industrial revolution, exit, and the failure of internal control systems. J Financ 48(3):831–880 Jensen MC, Murphy KJ (1990) Performance pay and top-management incentives. J Polit Econ 98 (2):225–264 John K, Ofek E (1995) Asset sales and increase in focus. J Financ Econ 37(1):105–126 Kang J-K, Lee I, Na HS (2010) Economic shock, owner-manager incentives, and corporate restructuring: evidence from the financial crisis in Korea. J Corp Financ 16(3):333–351 Kaplan SN, Weisbach MS (1992) The success of acquisitions: evidence from divestitures. J Financ 47(1):107–138 Kim CE (1998) The effects of asset liquidity: evidence from the contract drilling industry. J Financ Intermed 7(2):151–176 Klein A (1986) The timing and substance of divestiture announcements: individual, simultaneous and cumulative effects. J Financ 41(3):685–696 Lang LHP, Stulz RM (1994) Tobin’s Q, corporate diversification, and firm performance. J Polit Econ 102(6):1248–1280 Lang L, Poulsen A, Stulz R (1995) Asset sales, firm performance, and the agency costs of managerial discretion. J Financ Econ 37(1):3–37 Maksimovic V, Phillips G (2001) The market for corporate assets: who engages in mergers and asset sales and are there efficiency gains? J Financ 56(6):2019–2065 Manz F, Kiesel F, Schiereck D (2019) Do NPL portfolio sales help reduce banks’ financing costs? Econ Lett 182:93–97 Mitchell ML, Mulherin JH (1996) The impact of industry shocks on takeover and restructuring activity. J Financ Econ 41(2):193–229 Mulherin JH, Boone AL (2000) Comparing acquisitions and divestitures. J Corp Financ 6 (2):117–139 Myers SC, Majluf NS (1984) Corporate financing and investment decisions when firms have information that investors do not have. J Financ Econ 13(2):187–221 Owen S, Shi L, Yawson A (2010) Divestitures, wealth effects and corporate governance. Account Financ 50(2):389–415 Parlour CA, Winton A (2013) Laying off credit risk: loan sales versus credit default swaps. J Financ Econ 107(1):25–45 Pavel CA, Phillis D (1987) Why commercial banks sell loans: an empirical analysis. Economic Perspectives, Federal Reserve Bank of Chicago, July/August, pp 3–14 Pennacchi GG (1988) Loan sales and the cost of bank capital. J Financ 43(2):375–396 Powell R, Yawson A (2005) Industry aspects of takeovers and divestitures: evidence from the UK. J Bank Financ 29(12):3015–3040 Pulvino TC (1998) Do asset fire sales exist? An empirical investigation of commercial aircraft transactions. J Financ 53(3):939–978

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Rhodes-Kropf M, Robinson DT, Viswanathan S (2005) Valuation waves and merger activity: the empirical evidence. J Financ Econ 77(3):561–603 Rosenfeld JD (1984) Additional evidence on the relation between divestiture announcements and shareholder wealth. J Financ 39(5):1437–1448 Schlingemann FP, Stulz RM, Walkling RA (2002) Divestitures and the liquidity of the market for corporate assets. J Financ Econ 64(1):117–144 Shleifer A, Vishny RW (1989) Management entrenchment: the case of manager-specific investments. J Financ Econ 25(1):123–139 Shleifer A, Vishny RW (1992) Liquidation values and debt capacity: a market equilibrium approach. J Financ 47(4):1343–1366 Sicherman NW, Pettway RH (1992) Wealth effects for buyers and sellers of the same divested assets. Financ Manag 21:119–128 Slovin MB, Sushka ME, Ferraro SR (1995) A comparison of the information conveyed by equity carve-outs, spin-offs, and asset sell-offs. J Financ Econ 37(1):89–104 Slovin MB, Sushka ME, Polonchek JA (2005) Methods of payment in asset sales: contracting with equity versus cash. J Financ 60(5):2385–2407 Tehranian H, Travlos NG, Waegelein JF (1987) The effect of long-term performance plans on corporate sell-off-induced abnormal returns. J Financ 42(4):933–942 Warusawitharana M (2008) Corporate asset purchases and sales: theory and evidence. J Financ Econ 87(2):471–497 Yang L (2008) The real determinants of asset sales. J Financ 63(5):2231–2262

Chapter 5

Empirical Perspectives on Fire Asset Sales

Abstract What are the main factors leading distressed firms to sell assets in and out of bankruptcy court? What are the performance outputs for the distressed firms? Is it possible to identify fire sales, when assets are sold at a discount price compared to their fundamental values? In this chapter, we review major empirical findings about these issues in the literature, focusing on when distressed firms are forced to sell assets at a discounted price—i.e., in a fire sale—as opposed to being able to trade them at a fair price. We present empirical evidence about such fire sales vis-à-vis nonfinancial firms, banks, and security market intermediaries. Keywords Asset sale · Bankruptcy · Banks · Discount · Financial distress · Financially constrained firms · Fire sales · Nonfinancial firms · Security market intermediaries

5.1

Fire Sales in Nonfinancial Firms

A firm is in financial distress at a given point in time when its liquid and current assets are not sufficient to meet debt requirements. Mechanisms for resolving financial distress do so by disposing of assets or restructuring financial contracts, or both. In this section, we will deal with uses of the asset side of the balance sheet to generate cash to meet the requirements of contracts; these uses fall under the heading of asset restructuring.1 Many firms first attempt to resolve financial difficulties through asset sales. Assets can be sold, either piecemeal or in their entirety, to other firms and new management teams. Asset sales can be done privately or through court-supervised procedures—for example, during bankruptcy reorganization (e.g., Chapter 11 of the US Bankruptcy Code) or under a liquidation process (e.g., Chapter 7 of the US Bankruptcy Code). Each of these alternatives has advantages and disadvantages.

1 For a complete review of the issues related to the restructuring of financing contracts, see Hotchkiss et al. (2008).

© The Author(s), under exclusive licence to Springer Nature Switzerland AG 2020 C. Curi, M. Murgia, Asset Sales, SpringerBriefs in Finance, https://doi.org/10.1007/978-3-030-49573-2_5

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It is not uncommon for financially distressed firms to engage in private asset restructuring. These firms face a liquidity shortfall, yet are constrained in their ability to raise external funds to meet their obligations. In this situation, asset sales may serve as an alternative source of funds by which liquidity-constrained firms can generate cash and avoid more costly bankruptcy procedures. Bankrupt firms, instead, prefer restructuring in court, and asset restructuring through asset sales could be used both during the reorganization under Chapter 11 (prepackaged bankruptcies, or prepacks) and during liquidation under Chapter 7. In these two situations, firms are under pressure either to raise cash to keep financing current projects or to liquidate assets. That pressure leads firms to sell assets at depressed prices in their “fire sale” attempts to raise cash. A fire sale discount results when the observed transaction price is lower than an estimate of the assets’ fundamental value. Fire sales for voluntary asset sales can occur both in and out of Chapter 11. The literature highlights temporary demand-side conditions that may give rise to such discounts. For example, since financial distress tends to be contagious within an industry (Lang and Stulz 1992), high-valuation industry rivals may themselves be financially constrained and unable to buy even in an auction (Shleifer and Vishny 1992; Aghion et al. 1992). Industry debt overhang may also attenuate industry rivals’ incentive to invest in the bankrupt firm (Myers 1977; Clayton and Ravid 2002). When industry rivals are unwilling or unable to bid, the risk increases that relatively low-valuation industry outsiders will win the auction—at fire sale prices. The chance of this happening is greater for unique or specific assets with few potential buyers (Williamson 1988). Table 5.1 summarizes the main findings of the empirical literature on fire asset sales. Asquith et al. (1994) show that large asset sales are indeed often used as a mechanism for avoiding Chapter 11, but they are limited by industry economic conditions. Firms that are experiencing poor performance or that are highly leveraged are less likely to sell assets. The study by Asquith et al. finds that only 3 out of 21 companies (14%) that sell over 20% of their assets subsequently file for bankruptcy, as compared to 49% of firms with small or no asset sales. Firms that sell a large fraction of their assets are more likely to complete a successful debt restructuring (62% vs. 28%). The proceeds are often used to pay off senior private debt. Moreover, the probability of asset sales decreases with industry leverage, suggesting that asset sales may be limited by industry conditions. When a firm is in financial distress, asset liquidation value is likely to be below the book value of the firm’s liabilities, so that selling assets will inflict a loss in its balance sheet. Thus, unless creditors exert pressure for divesting, stockholders have little incentive to sell assets at lower prices to repay debt, particularly because liquidation eliminates equity options on any future increases in asset value. This suggests that credit pressure, particularly from short-term senior lenders, plays a pivotal role in decisions to liquidate assets and determines how sales proceeds are used. Empirical results by Brown et al. (1994), based on asset sales for a sample of 62 distressed companies, show that, contrary to the results for healthy firms, announcement returns are significantly lower for sellers who use the proceeds to repay debt than for sellers who use the proceeds for other purposes. Firms using sales

Firm type Financially distressed

Financially distressed

Financially distressed

Asquith et al. (1994)

Brown et al. (1994)

Lasfer et al. (1996)

1985– 1986

1979– 1988

Time period 1987– 1989

UK

USA

Country USA

142 firms

33 distressed but not bankrupt firm sample; 11 debt repayment sample; 22 other purpose sample

29 bankrupt firms; 19 debt repayment sample; 10 other purpose sample

Sample size 76 firms

2.33% bankrupt firm sample; 2.85% debt repayment sample; 1.74% other purpose sample 2.14% distressed but not bankrupt firm sample; 0.61% debt repayment sample; 3.59% other purpose sample 0.82% whole sample; 2.12% distressed firms; 0.49% healthy firms

Seller

CARs Buyer

Table 5.1 Summary of the main findings from the empirical literature on fire asset sales

[ 1;0]

[ 1;+1]

Event window

Linear regressions

Linear regressions

Econometric methods Probit regressions

CAR

Dependent variable Binary variable if the firm sells at least 20% of its assets CAR

(continued)

Debt financing ratio Asset-sale size

Cash proceeds used to repay debt bondholder CAR

Main explanatory variables Debt structure variables Industry variables

5.1 Fire Sales in Nonfinancial Firms 67

Filed for bankruptcy

Financially distressed

Brown (2000)

Firm type Financially distressed

Maksimovic and Phillips (1998)

Pulvino (1998)

Table 5.1 (continued)

1989– 1991

1977– 1990

Time period 1978– 1991

USA

USA

Country USA

92 REITs; 24 mortgage REITS; 20 hybrid REITs; 48 equity REITs

302 firms; 1195 plants

Sample size 704 narrowbody sales; 436 narrowbody purchases

1.91% mortgage REITS; nss. equity REITs

Several evidence

Seller

CARs Buyer

Event window

Binary variable if the buyer is a financial institution Binary variable if a plant is sold

Probit regressions

Logistic regressions

Dependent variable Asset-sale price

Econometric methods Hedonic and logistic regressions (two-step estimation)

Plant productivity Binary variables if before, in, and after Chapter 11

Main explanatory variables Aircraft quality characteristics (I step) Price residuals (II step) Leverage ratio (II step) Number of debt issues outstanding (II step) Leverage ratio Number of debt issues outstanding

68 5 Empirical Perspectives on Fire Asset Sales

Financially distressed

Both

Financially distressed

Filed for bankruptcy

Kruse (2002)

Brown et al. (2006)

Officer (2007)

Eckbo and Thorburn (2008)

1988– 1991

1979– 2003

1974– 1990

1985– 1992

SW

USA

USA

USA

258 bankruptcy auctions

417 standalone firms; 416 subsidiary firms

241 foreclosed assets

339 firms

–17% standalone private firms; 28% subsidiary targets

Linear regressions

Linear regressions

Hazard regressions (I step) Logistic regressions (II step)

Logistic regressions

Proceeds from the bankruptcy proceedings (I step) Debt recovery rate (I step) Auction price residual (II step) Recovery rate residuals (II step)

Binary variable if the firm makes an asset-sale during years 0–3 Binary variable if the repossessed asset is sold during a particular quarter (I step) Binary variable if the lender’s decision is to foreclose (II step) Acquisition discount

(continued)

Target assets (I step) Industry conditions (I step) Auction outcome (I step) Industry liquidity (II step) Auction outcome (II step)

Parent cash flow

REIT index prices (I step) Property type (II step)

Industry liquidity

5.1 Fire Sales in Nonfinancial Firms 69

Both

Firm type Financially distressed

1982– 2012

Time period 1988– 2009

USA

Country UK

Note: “nss” stands for not statistically significant

Meier and Servaes (2019)

Finlay et al. (2018)

Table 5.1 (continued)

21,850 whole sample; 428 fire sale sample; 21,422 no fire sale sample

Sample size 10,718 asset sales; 2425 distressed asset sales; 8266 non-distressed asset sales

11.23% whole sample; 0.76% fire sale sample; 11.50% no fire sale sample

Seller 1.05% distressed; 0.74% non-distressed

CARs

1.24% whole sample; 3.28% fire sale sample; 1.20% no fire sale sample

Buyer

[ 1;+1]

Event window [ 1;+1]

Linear regressions

Econometric methods Linear regressions

Seller’s CAR Seller’s peers CAR Seller’s customers CAR Seller’s suppliers CAR Employment change

Dependent variable CAR

Main explanatory variables Binary variable if negative net income Binary variable if the median stock price return of the industry is less than 30% Binary variable if recessionary quarter Binary variable if it is a fire sale

70 5 Empirical Perspectives on Fire Asset Sales

5.1 Fire Sales in Nonfinancial Firms

71

proceeds to repay debt are more likely to sell assets in poorly performing industries. Also, the greater the proportion of short-term bank debt, the more likely are the sale proceeds to be paid out to creditors, indicating that creditors may influence the decision to liquidate assets. The asset sales appear to benefit the creditors of the financially distressed firm more than its equity holders, suggesting that creditors may force a rapid asset liquidation. Lang et al. (1995), as shown earlier (see Sect. 4.2.1), find a positive stock price response to divestments motivated by the financing hypothesis, where sale proceeds represent a source of finance that would otherwise be difficult to obtain. Afshar et al. (1992) and Lasfer et al. (1996) find higher gains for divestment announcements by financially distressed UK firms, showing that sell-offs represent a mechanism for restoring financial health. Several US studies present evidence on fire sale discounts in voluntary asset sales, both in and out of Chapter 11. Beginning with Pulvino (1998), there is an extensive empirical literature on asset fire sales that test the implications of the model of such sales developed by Shleifer and Vishny (1992) (see Chap. 3). Shleifer and Vishny (1992) describe a model in which sellers of assets are forced to accept discounted prices because of negative economic shocks affecting a whole economic sector. Thus, asset fire sales are likely to be correlated across an industry, implying that potential industry buyers are also liquidity-constrained at the time their rivals want to divest subsidiaries. Shleifer and Vishny use this observation to predict asset fire sales, implying depressed sale prices when financially constrained firms sell assets and a greater likelihood that the assets will be sold to buyers outside the industry (where firms are not impaired by the industry shock). Evidence consistent with Shleifer and Vishny’s (1992) model predictions is reported in Pulvino (1998) (for used aircraft), Brown (2000) (for real estate investment trusts), and Kruse (2002) (for general corporate assets). The methodological issue raised by these empirical studies is how to measure the discount at which assets are liquidated. In theory, an asset’s fundamental value is the net present value of cash flows, but in practice determining fundamental value is complicated by the difficulty of identifying the specific asset-generated cash flows. As argued by Lang et al. (1995), it is difficult to disentangle fire sale effects from stock price reaction and the associated signaling values. Stock market reaction might convey information about the asset, but at the same time, it may signal what markets think about the intended use of the proceeds as well as the firm’s financial health. Relying on stock price reactions to liquidation announcement and interpreting positive reactions to mean that assets are not being liquidated at a discount to fundamental value could be misleading, given that the assets being sold may be reallocated to higher-value users, with this reallocation being reflected in positive stock reactions. Pulvino (1998), the first paper to examine the prices at which assets are liquidated, investigates data on asset sales in the airline industry. He shows that financially constrained airlines receive lower prices than unconstrained airlines when selling used aircraft, at a 14% discount relative to the average market price. This discount obtains when the airline industry is depressed but not when it is booming.

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Moreover, financially constrained airlines are more likely to sell to firms outside the aviation industry during market downturns, particularly to financial institutions such as banks and leasing companies, which then discount airplanes at around 30% relative to the average market price. Although discounted sales are costly for liquidating firms, they present a buying opportunity for conservatively financed firms. Overall, Pulvino (1998) finds that the effect of spare debt capacity on purchasing activity is greatest when asset prices are depressed. Brown (2000) carefully studied a systemic sale of real estate that originated from a widespread decline in property asset values. The systemic sales occurred in 1989, forcing lenders to sell foreclosed properties at distressed prices. Asset buyers were less leveraged firms. Brown et al. (2006) complement this empirical evidence by studying sales of commercial real estate assets by financially distressed firms over the period 1974–1990. They show that asset sales are delayed in the absence of wellcapitalized and deep-pocket investors. In the worst years of the real estate downturn, only about 12% of the foreclosed asset inventory was sold each year; by contrast, during the extended recovery of 1993 and 1994, between 30% and 40% of assets were sold and at lower discounts relative to fundamental value when compared to the sales completed during the downturn. Assets are found to have sold at 20–30% discounts relative to their fundamental value on average; fire sale discounts varied depending on market conditions at the time of loan foreclosure. Kruse (2002) generalizes the results of Pulvino (1998) and Brown (2000), finding that firms are more likely to sell assets if they find it challenging to raise debt capital. Interestingly, firms sell more assets if they experience turnover of their top officers or have made acquisitions prior to a performance decline. Officer (2007) analyzes discounts in asset sales of listed and unlisted targets outside of bankruptcy procedures. His paper provides evidence that liquidityconstrained firms often sell unlisted targets at substantial discounts to comparable listed targets, with the discounts ranging from 17% to 28%. Consistent with other studies, he also finds the asset-sale discounts are deeper when debt capital is relatively more expensive to obtain.2 However, Officer’s findings of a positive relationship between valuation and liquidity are not confirmed in a subsequent paper by Jaffe et al. (2019). They examine the effect of listing status on valuation, finding no discounts for either private or subsidiary targets. Jaffe et al. (2019) also address two important drawbacks of Officer’s (2007) methodology, namely, one-sided truncation of observations and Jensen’s inequality bias. With regard to the first issue, Officer (2007) uses the “comparable industry transaction method” to calculate acquisition discounts as the percentage difference between the acquisition multiple (price-to-book value of equity, price to earnings, deal value to EBITDA, or deal value to sales) for the unlisted target, on the one hand, and the average

2 Acharya et al. (2007) complement this literature, providing evidence in line with the Shleifer and Vishny’s (1992) model. Instead of examining the limited data available on asset sales, however, Acharya et al. (2007) study how industry distress affects creditor recoveries using comprehensive data on defaults in the United States. The data range from 1982 to 1999 and span all industries.

5.1 Fire Sales in Nonfinancial Firms

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corresponding multiple for the portfolio of comparable publicly listed targets, on the other hand. However, the drawback of this procedure is that it discards observations that show more than a 100% difference between the multiples in acquisitions of unlisted and listed targets. Jaffe et al. (2019) demonstrate that, depending on the multiple, this truncation eliminates as much as 50% of the available sample, making it difficult to generalize the results. In addition, since the truncation is one-sided, eliminating such a large fraction of the sample mechanically increases the size of the discount. With regard to the second issue, Officer calculates a discount for each target and then averages them across all targets in the sample. Jaffe et al. (2019) show that this procedure is subject to Jensen’s inequality bias and in fact reduces the discount. Eckbo and Thorburn (2008) test Shleifer and Vishny’s (1992) predictions for a sample of 263 bankruptcy auctions in Sweden in the period 1988–1991. They find evidence of conditional fire sale discounts in auctions that lead to piecemeal liquidation: a 1% increase in industry distress reduces piecemeal liquidation by 2%. Moreover, the probability of piecemeal liquidation is higher for targets with relatively tangible assets; it is also higher when industry-wide leverage ratios are high and the business cycle is in a downturn. Thus, industry-wide distress appears to increase both the probability of liquidation and the dislocation of prices. That said, auction prices in going-concern sales are statistically independent of the industry association of the buyer, and the probability that an industry outsider wins the target in a going-concern bid is unaffected by the distress variables. Finlay et al. (2018) investigate divestiture announcement stock return effects, controlling for firm-level financial distress conditions and similar factors at the industry level and also economy-wide. Their paper exploits a large sample of UK divestitures between 1988 and 2009. They isolate the impact of specific and overlapping distress conditions on how markets respond to these announcements, examining how firm and deal characteristics interact with these factors. This approach allows Finlay et al. (2018) to examine fire sale explanations as distinct from financing explanations vis-à-vis divestment announcements. In the literature, there is still controversy about the relative importance of these factors in explaining market reaction across different samples and time periods, in part because of the diverse definitions of financial distress that have been used in extant studies. However, results consistently find that the market reaction to divestment announcements during periods of industry-wide distress is significantly lower than for non-distressed firms; this pattern supports the fire sale explanation of asset sales. During these periods, the natural buyers of the divested assets are likely to be liquidity-constrained, so selling firms end up receiving lower prices. Fire sale effects from divestments are driven by financially constrained firms, firms selling core assets, and small firms. What is more, fire sale prices increase with deal size. Finlay et al. (2018) find some support for the financing explanation of the stock price response to divestments during periods of overlapping firm-level and economy-wide financial distress conditions, suggesting that divesting assets reduce the expected value of bankruptcy costs for selling firms under these conditions.

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Meier and Servaes (2019) investigate the effect of fire sales on the wealth of the buyers of these assets. They find that announcement returns to buyers are approximately 2 percentage points higher in fire sales than in regular M&As transactions. Moreover, selling firms’ shareholders in fire sales may not be in a position to bargain for a higher price or to delay the sale at all. Moreover, Meier and Servaes (2019) do not find evidence of real differences in the combined shareholders’ gains for buyers and sellers in fire sale transactions vs. regular transactions, leading to important policy implications. If the excess returns earned by buyers in fire sales represent a redistribution from sellers, then the need for bailouts to prevent fire sales is greatly reduced, especially because bailouts have further downsides, such as moral hazard, distortions due to political connections, and political capture of bailed-out firms. Contrary to previous results, then, from an overall welfare perspective, fire sales may be less costly than predicted by prior work, which focused on the cost of fire sales to the seller while ignoring the gains of the buyers. Maksimovic and Phillips’s (1998) early empirical work in this area shows that both industry- and plant-level productivity factors are more important than Chapter 11 bankruptcy status in influencing bankrupt firms’ decisions. Bankrupt firms sell plants at a higher rate than non-bankrupt firms, and they also sell their more productive assets. However, this difference is accounted for by sample selection and industry conditions, not by bankruptcy status. Maksimovic and Phillips (1998) argue that incentives to reorganize depend on the level of demand and industry conditions. Using plant-level data, they find that Chapter 11 status is much less important than industry conditions in explaining the productivity, asset sales, and closure conditions of Chapter 11 bankrupt firms. This suggests that firms that elect to enter into Chapter 11 incur few real economic costs. However, these results do not imply that buyers earn higher returns in fire sales, because what matters is the price at which the assets can be purchased.

5.2

Fire Sales in Banking

Parallel to the empirical literature on real asset sales by nonfinancial firms is the literature on financial and real asset sales by financial institutions. When banks face pressures that might induce them to sell assets quickly, the assets may be liquidated at distressed prices. On the one hand, binding capital constraints can cause a bank to deleverage through asset sales, focusing primarily on assets with the greatest risk weights.3 On the other hand, difficulties in meeting the liquidity demand of depositors can also induce a bank to sell illiquid assets quickly. Illiquidity on both the

3 Ramcharan (2020) notes that in the US banking system during the period 2001–2015, the ratio of tier 1 capital to risk-weighted assets—a key indicator of regulatory solvency—rose sharply beginning in 2008. Much of this increase stems from the shedding of capital-intensive assets, as the ratio of risk-weighted to total assets declines equally sharply over this period.

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assets and liability sides of the balance sheet can also interact to shape the liquidation value of collateral. Either because of equity constrains or illiquidity, the rapid disposal of assets when potential buyers have limited financial capacity can depress liquidation values relative to the fundamentals, possibly spilling over into real sectors such as the broader housing markets. Boyson et al. (2014) examine strategies that banks adopt for replacing lost funds when they face debt shortfalls during financial crises. In theory, two strategies can be pursued. Under the liquidity hypothesis, when debt markets tighten, banks should be forced to sell assets. However, under the solvency hypothesis, nearly insolvent banks will instead issue equity, cut dividends, and raise deposits before selling assets. For banks that must sell assets, the solvency hypothesis predicts that banks will cherrypick their assets, thus improving their equity capital. Cherry-picking is a regulatory arbitrage strategy that involves realizing gains on appreciated assets while avoiding selling assets with declining market values. Only after exhausting all of these options will banks resort to fire sales (i.e., selling assets at a realized loss). By studying a sample of US commercial banks over the period 1988–2008, Boyson et al. (2014) find little or no evidence of asset fire sales. The majority of banks that need funds in a crisis are not troubled by illiquid markets but rather by their own balance sheets. Fire sales are not found when banks have trouble rolling over debt. Instead, banks rely more on deposits and issue equity and sell off non-core assets at prices that improve, rather than deplete, their reported capital positions. Chu (2016) builds on the arguments proposed by Bolton et al. (2011), according to which a bank can meet the liquidity demand either by inside liquidity, that is, cash reserves, or by outside liquidity, that is, asset sales. However, if the bank has limited cash reserves, the bank has to rely on asset sales. Whereas there are many assets the bank can sell, real estate-owned (REO) properties are probably on top of the list for several reasons. REOs are properties purchased by banks or foreclosed properties that do not receive bids, or bids at very low prices, during foreclosure actions. They are recorded on banks’ balance sheets as Other Real Estate Owned. US regulations permit banks to hold REO properties for no longer than within 5 years after acquisition and require that banks dispose of these properties expeditiously but in accordance with prudent business judgment. Moreover, REO properties are not core assets of the bank, so selling them will not alter its business model. Furthermore, the bank with a low level of liquidity often has insufficient liquid assets to resort to, and the markets for other illiquid assets (such as industrial loans and mortgage-backed securities) either do not even exist or suffer from substantial information costs (Ellul et al. 2012). The bank, therefore, resorts to REO properties for liquidity. These type of asset sales might turn out to be fire asset sales, because the seller is under pressure to sell, and the buyers, too, are likely to be distressed during a financial crisis. Chu (2016) studies the real asset sales, namely, REO property, by commercial banks and reports findings consistent with the fire sale theory. He finds that low-liquidity banks are forced to sell REO properties due to regulations and liquidity constraints, post lower asking prices, sell at lower price, sell the properties more quickly, and are more likely to sell to non-natural buyers. Overall, the results suggest that low liquidity banks resort to fire sales when liquidating REO properties.

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Ramcharan (2020) provides the first detailed evidence that asset sales by financial institutions can significantly influence the liquidation values of real estate collateral and affect the broader residential housing market. By studying about 300,000 bankowned properties liquidation across 12 US states and 680 banks over the period 2006–2015, he finds that liquidation values tend to decline and the speed of asset sales tends to increase when banks lose deposits or deplete their equity buffers.4 Bank illiquidity is also associated with an economically large price rebound. Ramcharan’s (2020) findings also suggest that policies such as equity injections and central bank asset purchases might result in increased liquidation values by providing institutions with the balance sheet capacity to delay asset sales in down markets. REO properties are a capital-intensive asset class with sizeable risk weight (the risk weight on foreclosed real estate assets is twice as large as real estate loans in good standing). Overall, this evidence suggests that balance sheet adjustments at financial institutions can explain real asset price dynamics. Results of Granja et al.’s study (2017) on how the wedge between the willingness and the ability to pay distorts the allocation of failed banks is consistent with the presence of fire sales in this market (Shleifer and Vishny 1992). They examine the fire sale issue in the selling of failed banks and find that capitalization of potential acquirers distorts the allocation of failed banks. When banks that would like to acquire a failed bank are themselves poorly capitalized, the allocation of the failed bank is tilted toward acquirers whose characteristics suggest a lower willingness to pay.

5.3

Fire Sales in Security Markets

In asset-sale theory, Shleifer and Vishny’s (1992) capstone model can be easily adapted to a capital market setting. Organized secondary security markets typically have high transaction volumes, low execution costs, and a large number of willing buyers and sellers. However, main players in security markets are institutional investors who often follow specialized investment strategies with concentrated positions in a limited number of securities. These are all ingredients that create a relatively good environment to negotiate large transactions of securities; and, differently from real asset markets, this environment makes fire sales unlikely. Coval and Stafford (2007) analyze the case of open-ended mutual funds that are forced to sell portfolio holdings quickly when they do not have significant cash reserves to face capital flows and redemption demand by fund participants. Open-ended mutual funds are subject to both regulatory and self-imposed constraints that prevent them

4 A 1-standard-deviation decrease (increase) in deposits (interest rates) is associated with about a 1.5% drop in the liquidation value of real estate collateral in the next quarter, or about $2200 for the average property. A 1-standard-deviation decrease in the deposit-change variable is associated with about a 2-week decrease in the time remaining until a property sells.

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from raising funds quickly by, for example, short-selling other securities or avoiding margin requirements. Those institutional trades generate price pressure even in relatively (although not perfectly) liquid equity markets. Coval and Stafford’s (2007) experiment focuses on mutual fund transactions that are driven by financial distress and thus unlikely to be linked to opportunistic information-based trading. Nevertheless, even in such controlled environments, concentrated mutual fund sales forced by outflows exert significant price pressure in equity markets with transaction prices that deviate significantly from fundamental value. If those forced trades happen to overlap with other funds experiencing outflows, the cost of fire sales in security markets could be particularly high. Coval and Stafford (2007) also find that even extreme inflows could be severely costly, as they will force mutual funds to increase their holdings, creating significant demand price pressure. In the end, mutual fund fire sales as well as inflow-driven purchases produce trading opportunities for outsiders, given that forced transactions could be front run as they have some degree of predictability. Ellul et al. (2011) examine corporate bond sales by insurance companies following bond downgrades and find that insurance companies constrained by regulation are more likely to sell downgraded bonds at discounted prices. For their part, Barbon et al. (2019) study the behavior of brokers who intermediate fire sales, establishing the empirical value of being able to predict fire sales. To start, they present evidence of negative effects of fire sales in relatively liquid capital markets. When institutions are forced to trade large block of shares in a limited amount of time, predatory trading by informed brokers may occur, making the market more illiquid and amplifying price pressure effects. In this paper, the authors take advantage of a dataset that provides brokers’ order flow information. For example, in the case of hedge funds, prime brokers not only operate as lenders and risk managers but also know in advance when a fund is about to breach some risk limit and deleverage its portfolio. Brokers may also possess information about their clients’ trading strategies and practices, such as whether they tend to engage in stealth trading or piecewise block trading. Brokers may leak the news that a client’s block could be in one or more trading venues for some time, and other investors can use this information to predate on the selling fund. If the seller is under pressure because of financial distress, that may exacerbate the negative effects of the fire sale. Clearly, when a fund intends to liquidate a large number of securities, it will disclose little information about its intention and will likely use multiple brokers to minimize price impact and information leakage. The evidence in Barbon et al. (2019) is a recent example of how fire sales can have amplifying effects, even in relatively liquid markets, when financial intermediaries use their privileged information about who is selling assets and when, and also about how the assets are being sold.

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References Acharya VV, Bharath ST, Srinivasan A (2007) Does industry-wide distress affect defaulted firms? Evidence from creditor recoveries. J Financ Econ 85(3):787–821 Afshar KA, Taffler RJ, Sudarsanam PS (1992) The effect of corporate divestments on shareholder wealth: the UK experience. J Bank Financ 16(1):115–135 Aghion P, Hart O, Moore J (1992) The economics of bankruptcy reform. J Law Econ Org 8:523–546 Asquith P, Gertner R, Scharfstein D (1994) Anatomy of financial distress: an examination of junkbond issuers. Q J Econ 109(3):625–658 Barbon A, Di Maggio M, Franzoni F, Landier A (2019) Brokers and order flow leakage: evidence from fire sales. J Financ 74(6):2707–2749 Bolton P, Santos T, Scheinkman JA (2011) Outside and inside liquidity. Q J Econ 126(1):259–321 Boyson N, Helwege J, Jindra J (2014) Crises, liquidity shocks, and fire sales at commercial banks. Financ Manag 43(4):857–884 Brown DT (2000) Liquidity and liquidation: evidence from real estate investment trusts. J Financ 55 (1):469–485 Brown DT, James CM, Mooradian RM (1994) Asset sales by financially distressed firms. J Corp Finan 1(2):233–257 Brown DT, Ciochetti BA, Riddiough TJ (2006) Theory and evidence on the resolution of financial distress. Rev Financ Stud 19(4):1357–1397 Chu Y (2016) Asset fire sales by banks: evidence from commercial REO sales. Rev Corp Financ Stud 5(1):76–101 Clayton MJ, Ravid SA (2002) The effect of leverage on bidding behavior: theory and evidence from the FCC auctions. Rev Financ Stud 15(3):723–750 Coval J, Stafford E (2007) Asset fire sales (and purchases) in equity markets. J Financ Econ 86 (2):479–512 Eckbo BE, Thorburn SK (2008) Automatic bankruptcy auctions and fire-sales. J Financ Econ 89 (3):404–422 Ellul A, Jotikasthira C, Lundblad CT (2011) Regulatory pressure and fire sales in the corporate bond market. J Financ Econ 101(3):596–620 Ellul A, Jotikasthira C, Lundblad CT, Wang Y (2012) Is historical cost accounting a panacea? Market stress, incentive distortions, and gains trading. Working paper. University of North Carolina, Chapel Hill Finlay W, Marshall A, McColgan P (2018) Financing, fire sales, and the stockholder wealth effects of asset divestiture announcements. J Corp Finan 50:323–348 Granja J, Matvos G, Seru A (2017) Selling failed banks. J Financ 72(4):1723–1784 Hotchkiss ES, John K, Mooradian RM, Thorburn KS (2008) Bankruptcy and the resolution of financial distress. In: Eckbo E (ed) Handbook of empirical corporate finance, vol 2. Elsevier/ North-Holland, Amsterdam, pp 235–287 Jaffe JF, Jindra J, Pedersen DJ, Voetmann T (2019) Do unlisted targets sell at discounts? J Financ Quant Anal 54(3):1371–1401 Kruse TA (2002) Asset liquidity and the determinants of asset sales by poorly performing firms. Financ Manag 31(4):107–129 Lang LH, Stulz R (1992) Contagion and competitive intra-industry effects of bankruptcy announcements: an empirical analysis. J Financ Econ 32(1):45–60 Lang L, Poulsen A, Stulz R (1995) Asset sales, firm performance, and the agency costs of managerial discretion. J Financ Econ 37(1):3–37 Lasfer MA, Sudarsanam PS, Taffler RJ (1996) Financial distress, asset sales, and lender monitoring. Financ Manag 25(3):57–66 Maksimovic V, Phillips G (1998) Asset efficiency and reallocation decisions of bankrupt firms. J Financ 53(5):1495–1532 Meier J-M, Servaes H (2019) The bright side of fire sales. Rev Financ Stud 32(11):4228–4270

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Chapter 6

Conclusions

Abstract This concluding chapter offers our view on the restructuring challenges that firms will have to address in the near future. Extensive transformations of entire industries are inducing firms to evolve beyond their current scope and to scale up to meet fierce economic and competitive pressures—as well as regulatory pressures in the case of banks. Ultimately, firms should be able to transform their restructuring activities as tools to create value for both shareholders and bondholders. To this end, new theoretical approaches and empirical evidence are needed. Keywords Asset sale · Banks · Corporate efficiency · Discount · Financial distress · Financing · Financially constrained firms · Financing · Fire sales · Nonfinancial firms

Over the last few decades, asset sales have increasingly captured the attention of scholars in finance, economics, and management. Research in these areas has emphasized that firms need to have greater flexibility in designing their own boundaries and also a constantly changing approach to increasing scale and scope efficiency at both firm and industry levels. The development of the literature has paralleled the growing importance of asset sales for designing corporate capital structure, restructuring firms and industries, and providing external financing, particularly during periods of economic shock and financial market turbulence. As with other fields in finance, there can be no universal theory of asset sales. Thus, the theoretical literature has pursued a number of different directions, by modeling conditional theories. These theories overlap, sometimes making it difficult to distinguish them empirically. In general, however, differences among these theoretical models stem from the different factors they foreground in explaining corporate asset sale decisions. When such decisions are mostly motivated by the aim of restructuring firm assets and changing strategic plans, standard frictions based on differences in information, agency costs, and other market imperfections or institutional constraints have been used as key model assumptions. Assuming information asymmetries between insiders (e.g., managers and controlling shareholders) and outsiders (e.g., investors and intermediaries) with respect to asset sales’ expected cash flows and fundamental values, either contractual arrangements such as © The Author(s), under exclusive licence to Springer Nature Switzerland AG 2020 C. Curi, M. Murgia, Asset Sales, SpringerBriefs in Finance, https://doi.org/10.1007/978-3-030-49573-2_6

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competitive auctions or price mechanism adjustments are required to clear the market and reach equilibrium in asset sale markets. Agency arguments in the theoretical literature, meanwhile, have frequently considered how to force managers or insiders to sell assets that they might not be inclined to divest. Divestitures may be hard to justify to shareholders and external financers, since such actions can be interpreted as evidence of past mistakes or inadequate managerial oversight. Thus, to make it possible to complete divestitures, strong pressure on managers and controlling shareholders will be required. Such pressure, in agency-oriented models, derives from governance mechanisms, whether internal (e.g., boards of directors) or external (e.g., the takeover market), or from the process of replacing managers. The literature in this area has focused not only on asset sellers but also on the equally important role of buyers. Assuming a firm is selling a specialized asset, efficiency arguments predict that the more likely buyer would be an industry competitor. The economic efficiency theory emphasizes that asset sales are intended to reallocate capital investments to the most efficient user; thus, industry insiders are better positioned to know how to evaluate and make efficient use of the asset. However, industry shocks or a financial market crisis may harm a large spectrum of potential industry buyers, who, as a result, may lack the liquidity or borrowing capacity to acquire assets. When financial distress hits an industry, acquirers outside the industry—for example, financial investors—have to enter the asset market to complete deals with distressed sellers. Under such conditions, a new equilibrium is reached in the intercorporate asset market: sales will be transacted with both financially strong competitors and industry outsiders. However, outsiders may have limited knowledge about or capacities for managing specialized assets on sale. Therefore, outsiders with “deeper pockets” may provide external funding of last resort to financially distressed sellers by buying assets at discounted prices. Such conditions constitute “fire sales,” as indicated in early theoretical work in the field. Fire sales occur when sellers are financially distressed, assets are sold for less than their value, and acquirers can recover that difference when they resell the assets. The theoretical literature has also explored the relevance of asset sales in financing decisions. The idea is that divestiture proceeds are inflows that could be used either to repay debt or to undertake new investments. Asset sales are a financing mechanism that originates from the left side of corporate balance sheets; they therefore contrast with leading theories of capital structure, which focus mostly on explaining the proportions of debt and equity observed on the right-hand side of corporations’ balance sheets. In turn, empirical analyses of corporate asset sales have advanced our understanding of these important transactions. We can summarize the following stylized facts that have emerged from several decades of empirical studies: (a) Corporate asset sale transactions are likely to be procyclical and are observed at times of industry restructuring waves, because of deregulation and technological changes. Thus, and not surprisingly, asset sales cluster in parallel with mergers and acquisitions waves.

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(b) Asset sales provide the basis for subsequent growth. Firms that divest assets experience an increase in efficiency and productivity with respect to their remaining assets in the ex post period. (c) The liquidity of the market for corporate assets plays a crucial role in asset sales transactions, since it provides a relative priority ranking among the different assets that might be sold (from the more to the less liquid), while also indicating the best match between seller and buyer in terms of asset fungibility. (d) When a typical public firm announces the intention to sell an asset, stock price reactions are on average positive, particularly if the asset sale reduces the firm’s diversification. The positive stock market reaction is higher when firms announce that they will allocate asset-sale proceeds to repay debt, whereas the reaction is not significantly higher when sale proceeds are allocated to new investments. (e) Asset sales intensify at times of industry financial distress. In this situation, firms might sell assets at fire sales because they need cash to repay their debt. Foreign asset sales might allow the dislocated price of the sale to be maintained at the highest possible value. (f) Governance mechanisms could create positive incentives to induce firms to sell assets to reduce negative synergies, as well as to allocate the asset-sale proceeds efficiently—either to repay debt or to invest in new projects (tangible or intangible). Empirical evidence about asset sales in banking mostly concerns loan asset sales. Loan sales allow banks to obtain greater flexibility in adhering to key accountingbased parameters (e.g., capital and liquidity requirements) that regulations oblige them to meet. Loan sales also enable the kind of asset-liability matching that banks want to pursue in their business models. Firms’ restructuring activities will stay high on the research agenda in the near future, given the proliferation of disruptive developments and innovations, particularly new techniques of machine learning, new artificial intelligence capabilities, and new design techniques. Collectively, industries will be changed dramatically by the digitalization process. Entire industries will have to be reimagined in order to get ahead—or even catch up. Remaining static will lead to firms’ demise. In this context, firm restructuring through asset sales takes on a pivotal role, since such sales can provide firms with the flexibility needed to retain their franchises and ensure the success of entire industries. Although much is known about the stylized factors around asset sales, several areas remain unexplored. These areas call out for further research, with a view to enriching our understanding of this field of finance. In terms of country-level analysis, the existing literature focuses mostly on US firms, leaving the European landscape almost totally unexplored. Further, given the large number of unlisted firms, it would be interesting to consider whether unlisted sellers experience performance gains from asset sales and under what conditions. In addition, we have found that if the asset sales price is disclosed at the announcement date, sellers may experience a positive abnormal stock return. Given that effect, why

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are some sellers reluctant to disclose prices? What are the main features of these sellers—are they large or small, listed or unlisted? A fuller understanding of the underpinnings of the divestment process also requires exploring the distinction between the financing roles of asset sales in managerially controlled vs. owner-controlled firms. Furthermore, the even greater inherent conflicts between shareholders and debtholders in divestiture decisions are also an area where asset sales theory needs further development. Lastly, more research that takes account of the new wave of restructuring is needed. In particular, analysts should investigate whether asset sales of obsolete assets (whether hard or soft) are being traded in order to make investments in new technological assets and/or human capital resources. Research on asset sales in banking deserves fuller consideration, as the banking sector more than others has to keep reinventing its products and services—and to do so with a high level of cost-efficiency. Achieving such cost-efficiency is made all the more challenging not only by constant technological transformation but also by adverse economic conditions. These conditions are characterized, of late, by negative interest rates, as well as competitors outside the financial sector with greater flexibility in their business models. Asset sales, either through cash or equity, might be a strategic tool that the financial sector could use to redefine its boundary and scope, while ensuring continued adequate levels of operating and financial performance. In short, further research is essential if we are to grasp the effects of asset sales on firm performance and the competitiveness of entire industries, which must contend with the threat of economic uncertainty as well as stiff competition from young, innovative companies.