Divestments and financial distress in leveraged buyouts

This paper investigates the wealth effects of 134 divestments by 41 firms that underwent leveraged buyouts in the 1980s. Stock in these companies is privately owned. Bond returns for publicly traded debt are used to measure the wealth effects of the divestment announcement. These divestments are, on average, not associated with significant wealth effects for the full sample. However, firms that experience financial distress have negative and significant abnormal returns associated with their divestments, while returns in non-event months are insignificant. In contrast, non-distressed firms gain when asset sales are announced. The losses suffered by bondholders in distressed sellers are large and significant when core assets are divested. Bondholders in these firms do not suffer significant losses when non-core assets are divested. Finally, abnormal bond returns are related to the structure of the firms' post-buyout debt. Returns are negatively related to the use of private debt in the capital structure and positively related to the use of subordinated debt.     

The Choice Between Spin-offs and Sell-offs

Spin-offs and sell-offs are alternative methods for divesting assets, but the effects on the parent firm differ substantially. We examine firms' characteristics that may influence the asset divestiture choice between a spin-off and sell-off. Results of the analysis indicate that the primary factors influencing the choice of divestiture type are financial distress, number of directors on the board, whether the CEO is also the Board Chair, and the size of the unit divested.     

Wealth effects for acquirers and divestors related to foreign divested assets

This study examines acquisitions of foreign divested assets by U.S. firms. The results indicate that the excess returns to these acquisitions is a significant 0.48%, suggesting that capital markets perceive potential synergies from the effective utilization and strategic management of these assets by U.S. companies. The wealth effects to divestors of these foreign assets is 0.65%, significant at the 1% level, indicating that firms benefit from reducing their geographic scope of operations. We further examine excess returns to acquirers, and we find that several firm-specific characteristics foster anticipation of positive performance gains resulting from the acquisition of divested assets in foreign countries. Similar results are observed for the divesting firms also. Analysis of long horizon performance provides weak indication that performance of divesting firms improves subsequent to the divestment.     

The impacts of racial differences on demand for financial assets

The purpose of this study is to examine the impacts of racial differences on the demand for financial assets by individuals. Differences in the demand for financial assets by various racial groups would have important implications not only for monetary policies but also for aggregate studies based on the representative agent model. According to the Gorman form of commodity demand, the validity of the representative model is critically dependent on the assumption that marginal propensities to hold financial assets are constant across individuals regardless of their socio-economic characteristics. Findings in this study indicate that the elasticity of wealth, marginal propensities, and the elasticity of user cost vary substantially among Whites and African Americans.     

Voluntary Divestitures and the Choice Between Sell-Offs and Spin-Offs

A voluntary divestiture may either be a sell-off or a spin-off. In a sell-off, the divesting firm receives cash (or cash equivalents) and gives up ownership and control of the divested asset. In a spin-off, the divested asset becomes an independent entity under a new management but ownership remains with the old stockholders of the original firm. The study investigates the divestiture decision and the choice between sell-offs and spin-offs by constructing a model of the multi-divisional firm. The results show that firms undertake voluntary divestitures because of low marginal return coupled with high joint operating and financial costs. The form of the divestiture is determined by the operating risk of the division being divested. The implications of the model are empirically tested for the period 1969–87 and the results support the postulates of the model.     

Managerial rights,use of investment banks,and the wealth effects for acquiring firms’ shareholders

We examine the relation between managerial rights in acquiring firms and the decision to use an investment bank in merger and acquisition deals, and explore whether this relation impacts the wealth effects for acquiring firms’ shareholders. We find that acquiring firms whose managers have relatively strong rights are more likely to use investment banks to facilitate deals and are more likely to use reputable banks. The wealth effects to acquiring firms are inversely related to the use of investment banks when managerial rights are relatively strong. However, the wealth loss is mitigated when acquiring firms use reputable investment banks.     

Managing markets for toxic assets

A model in which banks trade toxic assets to raise funds for investment is analyzed. Toxic assets generate an adverse selection problem and, consequently, the interbank asset market provides insufficient liquidity. Investment is inefficiently low because acquiring funding requires banks to sell high-quality assets for less than their “fair” value. Equity injections reduce liquidity and may be counterproductive as a policy for increasing investment. Paradoxically, if it is directed to firms with the greatest liquidity needs, an equity injection will reduce investment further. Asset purchase programs, like the Public–Private Investment Program, often have favorable impacts on liquidity, investment and welfare.     

Acquirer-target social ties and merger outcomes

This article investigates the effect of social ties between acquirers and targets on merger performance. We find that the extent of cross-firm social connection between directors and senior executives at the acquiring and the target firms has a significantly negative effect on the abnormal returns to the acquirer and to the combined entity upon merger announcement. Moreover, acquirer-target social ties significantly increase the likelihood that the target firm?s chief executive officer (CEO) and a larger fraction of the target firm?s pre-acquisition board of directors remain on the board of the combined firm after the merger. In addition, we find that acquirer CEOs are more likely to receive bonuses and are more richly compensated for completing mergers with targets that are highly connected to the acquiring firms, that acquisitions are more likely to take place between two firms that are well connected to each other through social ties, and that such acquisitions are more likely to subsequently be divested for performance-related reasons. Taken together, our results suggest that social ties between the acquirer and the target lead to poorer decision making and lower value creation for shareholders overall.     

Corporate Insurance and Debt: The Case of China*

Finance theorists have long argued that corporate purchases of property insurance can reduce the probability and hence the expected costs of financial distress. And by so doing, the corporate use of insurance can reduce borrowing costs and/ or increase debt capacity, reduce the overall cost of capital, and increase firm value. This article attempts to apply this argument to the case of publicly traded companies in China, which provides a particularly interesting environment given the significant presence of both foreign direct investment and state shareholdings in its corporate sector. From their study of several hundred Chinese companies during the period 1997‐2003, the authors report the following conclusions: Companies with higher borrower costs tend to purchase more property insurance, which in turn has the effect of increasing their debt capacity. Smaller companies are more likely than larger firms both to insure their assets and to purchase more property insurance (as a percentage of assets), reflecting their greater vulnerability to financial shocks and larger potential benefit from insurers' real advisory services (such as loss prevention advice). Companies with more and larger growth opportunities are more likely to purchase insurance, reflecting their higher expected costs of financial distress (from possible underinvestment) than firms with limited growth opportunities. Companies with higher levels of state ownership tend to insure their assets to a greater extent, suggesting that the managers of such companies insure to protect their job security, particularly as the availability of state subsidies to the Chinese corporate sector has declined since market reforms were initiated in 1978.     

Financial crises,unconventional monetary policy exit strategies,and agents׳ expectations

A central bank may purchase assets during a financial crisis and then exit from those purchases. Agents have rational expectations about financial crises as rare events, the probability the central bank purchases assets, and the exit strategy. Selling off assets quickly produces a double-dip recession while slowly unwinding generates a smooth recovery. Expectations about the exit strategy influence the initial effectiveness of purchases. Increasing the probability of purchases during crises distorts the pre-crisis economy and depends upon the exit strategy. The welfare benefits of unconventional policy may differ ex-ante versus ex-post, as can the preferred exit strategy.     

Signaling,Financial Slack and Corporate Acquisitions

This paper shows that under certain conditions a firm's decision concerning the optimal medium of exchange to use in acquiring another firm is related to the decision of which source of capital should be used to finance long-term projects. An example of this type of interaction occurs when the firm's only source of financing a positive net present value project is an equity issue. In a Myers and Majluf (1984) world of asymmetric information the value maximizing strategy for the firm is to forego the public equity offering and instead use a stock offer to acquire a firm possessing financial slack. The process is modeled using an extension of the Myers and Majluf (1984) model and demonstrates how the acquisition alternative allows managers to separate the signals regarding the investment and financing decisions. Including net pension assets into our measure of financial slack, we provide empirical supports for the ability of the extended model to explain observed merger activity.     

Analyst Coverage and Intangible Assets

This study examines the relation between analysts' incentives to cover firms and the extent of their intangible assets. Because intangible assets typically are unrecognized and estimates of their fair values are not disclosed, absent analyst coverage firms with more intangible assets likely have less informative prices. Accordingly, we expect analysts have greater incentives to cover firms with more intangible assets and, thus, predict they have higher analyst coverage. As predicted, we find that analyst coverage is significantly greater for firms with larger research and development and advertising expenses relative to their industry, and for firms in industries with larger research and development expense. We also predict and find that analyst coverage is increasing in firm size, growth, trading volume, equity issuance, and perceived mispricing, and is decreasing in the size of the firm's analysts' brokerage houses and the effort analysts expend to follow the firm. These findings indicate that analyst coverage depends on private benefits and costs of covering a firm. We also test hypotheses related to analyst effort. We predict and find that analysts expend greater effort to follow firms with more intangible assets, after controlling for other factors associated with analyst effort. Our evidence indicates that intangible assets, most of which are not recognized in firms' financial statements, are associated with greater incentives for analysts to cover such firms, and greater costs of coverage. An open question is whether financial statement recognition of intangible assets could more efficiently provide information about such assets to investors.     

THE WEALTH EFFECTS OF VOLUNTARY SELLOFFS: IMPLICATIONS FOR DIVESTING AND ACQUIRING FIRMS

Previous research examining the wealth effects of voluntary selloffs has shown positive stock price movements around the announcement date for divesting firms. Shareholders realize positive economic gains from selloffs. One recent study indicates that shareholders of acquiring firms also realize economic gains. This study examines the division of economic gains between divesting and acquiring firms and the impact of the firm's financial condition and relative selloff size on the level of economic gains. Significant positive price movements are observed for divesting firms immediately prior to and on the announcement date. Some evidence of positive, although not significant, price movements is found for acquiring firms. These results suggest shareholders of divesting firms realize economic gains from selloffs while shareholders of acquiring firms neither gain nor lose. Also, as divesting firms sell off larger portions of their total assets, their shareholders realize greater economic gains; the division of economic gains becomes more one-sided (in favor of divesting firms) as the relative size of the selloff increases.     

Financial factors and firm growth: evidence from financial data on Taiwanese firms

We investigate the possible predictability of firm growth in Taiwan using cross-sectional data of financial factors for the years 1997 and 2003 via principal component analysis. Our results reveal that the 18 financial variables (sales growth rate, total assets, total sales, return on assets, return on equity, gross margin, operating cost minus depreciation divided by sales plus other trading income, acid test ratio, debt–equity ratio, time interest earned, average receivables per average daily sales, inventory, average payables per average daily sales, working capital, working capital as a fraction of total assets, long-term liabilities as a fraction of total assets, and sales as a fraction of net worth of the firm) that we employ bunch together into five different financial ratios for the years 1997 and 2003 that are stable between these years. These financial factors are short-term liquidity, return on investment, long-term liquidity, firm size and capital turnover. Regressing these ratio groups (extracted principal components) on firm growth, we find return on investment in the year 1997 was positively and significantly related to firm growth, while long-term solvency was negatively related to firm growth. In addition, smaller firms tended to grow faster. By 2003, larger firms grew faster than smaller ones and short-term liquidity was positively and significantly related to firm growth, while return on investment was no longer a significant determining factor. Our findings suggest that firms that finance internally or do not rely too heavily on indebtedness may end up growing slower during boom periods but they are the ones that survive and outperform after the bust.     

The Impact of the European Union Insurance Directives on Insurance Company Stocks

This article examines the impact of the passage of the Second and Third Life and Non‐Life European Insurance Directives on insurance firms located in 14 European Union countries, Norway, and Switzerland. The third directives have a wealth effect on the European insurance market, while the second directives do not. The Third Life Directive resulted in a wealth increase for the European insurance market, while the Third Non‐Life Directive had a modest negative wealth effect. The wealth effects differ at both the country and firm level. The directives have differential impacts on firms depending on the firms’ characteristics and those of the market they operated in prior to the directives. Regression results indicate that the second directives have impacted firms in protected markets negatively, especially those with higher debt and higher returns on assets. At the time of the third directives, insurance firms benefited, even those in previously protected markets, indicating that firms may have positioned themselves in preparation for the liberalization of the laws.     

THE IMPACT OF SALE-LEASEBACKS TRANSACTIONS ON BONDHOLDER AND SHAREHOLDER WEALTH

Prior research has shown that a sale and leaseback transaction (SLBT) results in positive average abnormal returns to the lessee's common stockholders. Researchers have conjectured that this could be due to SLBT tax benefits or due to a wealth transfer from bondholders (since after the SLBT it is possible that fewer assets remain as collateral). This study shows that bondholders do not lose in SLBT's and confirms previous results showing that stockholders gain from sale leaseback transactions. The results are consistent with the position that bondholders write provisions to protect their rights to the underlying assets, resulting in no wealth transfer from bondholders to stockholders when the firm sells off assets and leases them back.     

Corporate Acquisitions,Diversification, and the Firm's Life Cycle

Agency theories predict that older firms make value‐destroying acquisitions to benefit managers. Neoclassical theories predict instead that such firms make wealth‐increasing acquisitions to exploit underutilized assets. Using IPO cohorts, we establish that, while younger firms make more related and diversifying acquisitions than mature firms, the acquisition rate follows a U‐shape over firms’ life cycle. Consistent with neoclassical theories, we show that acquiring firms have better performance and growth opportunities and create wealth through acquisitions of nonpublic firms throughout their life. Consistent with agency theories, older firms experience negative stock price reactions for acquisitions of public firms.     

A further look at household portfolio choice and health status

This paper investigates the effect of changes in health status on household financial wealth and financial portfolio choice. It is shown that the impact of health events on household financial and non-financial wealth is asymmetric. A diagnosis of a new disease leads to a larger decrease in financial wealth than in non-financial wealth. Moreover, we find that the puzzle pertaining to the relationship between health status and portfolio choice discussed in the extant literature generally disappears after controlling for differences in the amount of financial assets held by healthy and sick people. The results suggest that the effect of changes in health status on household financial portfolios is indirect. A health shock significantly reduces household total financial wealth, in turn leading households to restructure the composition of their financial assets.     

Is domestic consumption dragged down by real estate sector?—Evidence from Chinese household wealth

This paper investigates whether domestic consumption dragged down by real estate sector, using the panel data of China Family Tracking Survey (CFPS) in 2012, 2014 and 2016. This paper constructs the consumption structure upgrading index represented by food, daily necessities and cultural, educational and entertainment expenditure according to the industrial upgrading rate, and builds a model based on LC-PIH theory to analyze whether the change of household wealth has wealth effect on residents consumption. Through empirical analysis, this paper finds that risk-free financial assets have a squeezing effect on household consumption, and risky financial assets, net real estate and productive fixed assets have a significant wealth effect on household consumption. Finally, this article proposed how to promote the upgrading of Resident Consumption Structure in China.     

Wealth,Composition, Housing,Income and Consumption

The present research covering the latest residential boom and bust cycle highlights the lack of uniform or constant time invariant wealth, housing and income relations. More important, wealth composition is shown to be a significant determinant of consumption. The marginal effects of housing equity, financial wealth and income differ substantially based on the composition of household wealth. Households with the highest percentage of net worth in financial assets have much lower income effects, have substantially higher marginal effects associated with stock holdings and have housing equity effects that differ noticeably from other households. Income effects for groups with the smallest amounts of relative financial wealth are dramatically higher than for households with greater financial wealth. Wealth and its composition affect consumption.