Foreign and domestic contraction: Theory and empirical tests

The purpose of this study is to develop and empirically test theories on wealth effects surrounding divestiture of foreign and domestic subsidiaries by U.S. firms. Two primary research questions are addressed: (1) What are the wealth effects associated with divestiture of foreign and domestic subsidiaries? (2) How do firm-specific and macroeconomic conditions affect these wealth effects? Various methodologies are used to empirically test theories and hypotheses. Two samples of divestitures that occurred between 1979 and 1991 are used. One sample consists of 111 divestitures of foreign subsidiaries by U.S. firms, and the other sample consists of 148 divestitures of domestic subsidiaries by U.S. firms. The results of this study are relevant to corporate managers, investors, security analysts, and other researchers. Foreign and domestic divestitures elicit positive short-run valuation effects of about 1 and 2 percent respectively. In the long run, firms that divest foreign subsidiaries increase in value on average by about 15 percent over a 5 year post-divestiture period. Conversely, firms that divest domestic subsidiaries decrease in value on average by about 11 percent over the 5 years that follow divestiture. No significant change in firm risk is associated with foreign or domestic divestitures. Relations between short-run and long-run valuation effects in the sample of domestic divestitures are positive and significant for periods of up to 4 years after divestiture, but for foreign divestitures, such relations are not significant. This suggests that the market adjusts more slowly but seems to more accurately predict the long run impact of domestic divestitures. Large divestitures elicit large valuation effects. Financially strong firms divesting foreign subsidiaries experience less favorable valuation effects. Greater valuation effects result from divestiture of unrelated subsidiaries. Strategic divestitures elicit positive valuation effects in the short run but little unique effect in the long run. Domestic divestitures that occur because of liquidity problems elicit positive valuation effects. Larger valuation effects are associated with divestiture of foreign subsidiaries in industrial countries than in less developed countries. A strong U.S. dollar seems to have a positive influence on short-run valuation effects but no material influence on long-run valuation effects associated with foreign divestiture.