An analysis of firm life cycle and financial distress : evidence from UK divestitures

  • William Finlay

Student thesis: Doctoral Thesis


This thesis examines the shareholder wealth effects of divestiture transactions via an analysis of event study announcement returns. It examines the factors determine changes in the level of returns, with a specific focus on the following areas: What role does firm life cycle play in the observed abnormal returns to divesting UK firm shareholders? Motivated by a growing body of research utilising a cutting edge measure of firm life-cycle by De Angelo et al. (2006), chapter 4 examines the impact of firm life-cycle on the announcement returns to firms undertaking divestiture activity. Developing the early research by Pashley and Philippatos (1990, 1993) who try to examine divestiture activity and life-cycle for the first time, the chapter examines whether the stock market responds to divestiture announcement differently across a firm life-cycle stage and whether agency concerns or other factors influence the level of shareholder returns. The presence of agency costs have been shown by Kaiser and Stouraitis (2001) to have a significant impact on divestiture activity. The results show that the wealth impact of divestiture activity varies by different firm life-cycle stages, those firms at the later life-cycle stages experience higher abnormal returns than earlier stages. The results suggests support for the agency cost of managerial discretion hypothesis, firms are rewarded for reconfiguring their operations back to an optimal size and for reducing the agency costs of managerial discretion. There is limited evidence to suggest that agency cost concerns are associated with higher abnormal returns near the end of the firm life-cycle, however these results disappear when re-configuring life-cycle definitions. Separately, those firms with negative retained earnings outperformed those with positive retained earnings irrespective of life-cycle stage, suggesting financial distress plays an important role in the level of returns experienced by firms undertaking divestiture activity. What role does the financial condition of the divestor have on the abnormal returns of UK firms? Chapter 5 examines the impact the impact of firm financial distress across multiple measures of firm-level financial distress (Taffler z-score, interest coverage measure and a net income measure). The chapter examines the financing hypotheses to assess whether firm level financial distress is a factor that influences the shareholder wealth effect to divesting firm shareholders. The financing hypothesis posits that asset sales by financially distressed firms will result in positive share price response given a reduction in the expected costs of financial distress (Lang et al., 1995). The positive announcement returns are attributable to divestiture activity representing a lower cost source of financing periods when a firm is facing financial distress. The results show that divestiture activity by financially distressed firms result in significant wealth gains to divesting firms across all three separate measures of financial distress.;The key findings support the financing theories of asset sales. The chapter contributes to the literature on firm financial distress by examining multiple measures of firm distress and extending these to examine distress is a multi-dimensional approach incorporating liquidity and leverage. Liquidity and leverage are found to be a significant factor in explaining abnormal returns experienced by divesting firms, it is observed that firms with a strong bargaining positions are able to extract better prices from the sale. What role does the business environment (firm's industry and the macroeconomic environment) have on the observed abnormal returns of divestitures by UK firms? Chapter 6 examines the impact of financial distress, across firm level, industry level and the overall macroeconomic level on the market reaction to divestiture announcement. The chapter examines the conflicting financing and fire sale hypotheses in order to bring together the themes of external market conditions, availability of buyers and the financial condition of the divesting firms to assess these factors on the shareholders of firms that announce divestiture activity. The results show that shareholders experience significant wealth losses when firms sell assets during periods of industry distress. Natural buyers of the asset during this period are also likely to be distressed and as such the firms divesting assets will receive a lower level of cash proceeds from the asset sale (Shleifer and Vishny, 1992). Some evidence is found to support the financing hypothesis for those firms divesting during periods of firm and economic-distress. The chapter contributes to the literature on divestiture by examining the interactions between the financial distress conditions and the distress conditions in isolation. Industry conditions are found to dominate the results. Overall, the results show that fire sale conditions prevail during periods of industry distress, but the financing benefits at the firm level can offset the fire sale discount. The evidence presented in this thesis contributes to the growing body of research on corporate divestitures. Specifically that the growth opportunities, the financial state of the seller, the bargaining position and the market conditions at the time of the divestiture can adversely impact the level of abnormal returns experienced by firms undertaking divestiture activity.
Date of Award26 Aug 2015
Original languageEnglish
Awarding Institution
  • University Of Strathclyde
SponsorsUniversity of Strathclyde

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