The Evolution of Corporate Divestment: Towards a New Research Paradigm?

The Evolution of Corporate Divestment: Towards a New Research Paradigm?

Pedro Miguel Freitas da Silva (University of Aveiro, Portugal) and António Carrizo Moreira (University of Aveiro, Portugal)
DOI: 10.4018/978-1-5225-6301-3.ch015

Abstract

When compared to other fields of research such as mergers and acquisitions, corporate divestment is under researched. There are at least three main reasons for this: the environment in which corporate divestment research has taken place has caused divestments to be understood as acquisition-driven rather than strategy-driven, the scope and distinct modes of divestment, and the difficulties in isolating the divestment phenomena. The objective of this chapter is to review the main theoretical approaches used in the study of divestment, to analyze their contribution to the field, and to discuss whether new approaches are needed in divestment research. Most studies of divestment are based on the concept that divestment is the outcome of poor unit performance, and the reversal of previous over-diversification and growth strategies that expanded the company size beyond optimal control. This chapter proposes four future lines of research into corporate divestment: the international business strategy, the network perspective, the stakeholders' perspective, and the institutional theory.
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Introduction

In a continuously changing world, flexibility and responsiveness emerge as some of the key competitive factors for businesses. Corporate divestment is a “firm’s decision to dispose of a significant portion of its assets” (Duhaime & Grant, 1984; p. 301). Corporate divestment is a common and growing phenomenon. Johnson (1996) found 1200 divestments worth 59.9 billion dollars in 1986 alone. Bergh & Lawless (1998) mentioned that during the 1980s and into the 1990s, almost one half of Fortune 1000 companies had engaged in divestments, acquisitions or both. More recently, Gadad, Stark, & Thomas (2009) observed that the scale of divestments in the United Kingdom was on average 40% of the activity in the merger market and reached levels as high as 70% in some years. Nowadays examples of corporate divestment can be found everywhere. According to UNCTAD (2016), European firms have divested from developing economies like Asia or Latin America. Caterpillar announced the shutdown of its plant on Illinois, cutting 800 jobs (Reuters, 2017). General Motors closed five of its factories in the US during 2017 (Fortune, 2017). US hard drives and data storage manufacturer Seagate closed one of its largest factories, the Suzhou China plant, in 2017, laying off 2,127 employees on what China’s Ministry of Commerce classified as a “normal business decision” (Xinhua, 2017).

Corporate divestment is an important topic with an impact on company performance and competitive position. Dranikoff, Koller, & Schneider (2002) highlight how divestments were a keystone of General Electric strategy under the leadership of Jack Welch in the first four years of his tenure as CEO, as he divested 117 businesses accounting for 20% of General Electric’s assets. Greg Summe, CEO of PerkinElmer, used divestments and acquisitions to reshape the company from a supplier with low margin services to an innovative high-tech company. A McKinsey & Company study shows that companies that actively manage their business portfolio through acquisitions and divestments deliver more value to shareholders than those that passively hold them. Dranikoff, Koller, & Schneider (2002), argue that divestment is a way to dispose of a business whilst ensuring that the remaining divisions reach their full potential and the overall company grows stronger. Thus, divestments can strengthen and rejuvenate a company and may constitute an important strategic tool for management. Nonetheless, there seems to be a bias against divestment as managers are traditionally reluctant to divest because of its association with weakness and failure (Dranikoff et al., 2002; Porter, 1976).

Regardless of its importance, corporate divestment has received scarce attention when compared to other forms of restructuring such as mergers and acquisitions (M&A) and strategic alliances (Gadad et al., 2009; Lee & Madhavan, 2010). As a result, still relatively little is known about the reasons as to why companies divest (Berry, 2013). Existing literature has examined the divestment phenomenon using a variety of theoretical approaches including the internationalization theory, imperfect market conditions and the governance issues caused by directional conflict between shareholders and managers. With the development of globalization, the traditional theories used to explain divestment have been increasingly challenged. Villalonga & Mcgahan (2005) claim that the various divestment theories, rather than being mutually exclusive, appear to be closely related and complementary.

Key Terms in this Chapter

Market Exit: A company’s strategic decision to withdraw or abandon a certain market because of financial losses, poor profitability, low future expected returns, or to reshape its business, among others.

Corporate Strategy: The direction the company follows and how it uses its internal resources considering the external environment in which the company competes to generate value to its owners and satisfy its customers. Corporate strategy includes for example cost leadership or product differentiation strategies.

Divestment: The partial or complete disposal of a whole company, a segment, a division, a business unit or an asset. Can be conducted through various legal forms such as downgrading, closure, sell-off, spin-off, spin-out, equity carve-out, split-off, split-up, leveraged buyout, management buyout.

Corporate Restructuring: A process that involves changing and reorganizing the structure of a company. Corporate restructuring can concern to: organizational restructuring such as the change of organizational structure, systems or practices, downsizing of workforce; financial restructuring such as management buyouts, leveraged buyouts or asset sell-offs; and portfolio restructuring such as divestments, dissolutions and mergers and acquisitions.

International Business: All activities that include the trade of goods, services, technology, capital, skills and knowledge between two countries at a global level.

Merger and Acquisition: Transaction in which the ownership of a company or its units are transferred or combined. Includes mergers, in which two entities are combined in one entity; and acquisitions, in which one entity take another one stock, equity interest or asset.

Business Diversification: Diversification is the corporate decision to enter a new business or a new market in which the company currently does not operate. Business diversification can be driven by defensive reasons such as decreasing the risk of a market contraction, or offensive ones like taking advantage of a market opportunity. Diversifying companies expect to obtain the benefits of diversification like increasing growth and profitability, but also face the risks of going into an unknown market.

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