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Takeover-divestiture combinations and shareholderwealthChristopher J. Marquette a & Thomas G. E. Williams ba Division of Behavioral Sciences , University of Pittsburgh at Greensburg , 1150 Mt PleasantRoad, Greensburg, PA 15601, USAb Department of Managerial Economics and Finance , Fayetteville State University ,Fayetteville, NC 28301, USAPublished online: 24 Apr 2007.

To cite this article: Christopher J. Marquette & Thomas G. E. Williams (2007) Takeover-divestiture combinations andshareholder wealth, Applied Financial Economics, 17:7, 577-586, DOI: 10.1080/09603100600722169

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Applied Financial Economics, 2007, 17, 577–586

Takeover-divestiture combinations

and shareholder wealth

Christopher J. Marquettea,* and Thomas G. E. Williamsb

aDivision of Behavioral Sciences, University of Pittsburgh at Greensburg,

1150 Mt Pleasant Road, Greensburg, PA 15601, USAbDepartment of Managerial Economics and Finance, Fayetteville State

University, Fayetteville, NC 28301, USA

Situations in which a firm is taken over by another and then subsequently

spun off are of interest, because it is not clear whether the spin off is the

reversal of a bad decision or the second part of a deliberate action to

extract value from the target firm. To explore these issues, we analyse the

effect of the takeover and divestiture on the value of the firm that initiates

these takeovers. There is a negative wealth effect for the firms that

undertake these transactions upon the announcement of the takeover and a

positive wealth effect for the spinoff. However, the combined wealth effect

of the takeover and spinoff is not significant. Regressing this total ‘round-

trip’ wealth effect for each firm on accounting and financial characteristics

of the firm targeted in the takeover reveals a positive relation between total

wealth effect and research and development expenditure in the target firm.

The results are consistent with the hypothesis that takeover-divestiture

combinations can increase shareholder wealth when they target firms that

have growth opportunities that can be appropriated.

I. Introduction

We observe instances where a firm takes over anotherfirm and then subsequently spins it off. Previousstudies have offered two alternate explanations forthese occurrences. The first explanation is that thespinoffs are corrections of takeovers that weremistakes. A second explanation is that a spinoff wasthe original intent prior to the takeover, with thetakeover firm extracting some value from the take-over-divestiture combination.

Previous studies such as Daley et al. (1997),Kaplan and Weisbach (1992), Mitchell and Lehn

(1990), Hite and Owers (1983) and Miles andRosenfeld (1983), have investigated the wealth

effects of takeovers and divestitures. Several studies

measure the stock price reaction to announcements

of these actions individually. Overall, price reaction

to the announcement of takeovers is negative for thefirm initiating the takeover (the ‘bidder’ firm) and

positive for the firm being taken over (the ‘target’firm).

Fluck and Lynch (1999) provide a theoreticalframework for why it may be advantageous totake over and subsequently divest a firm. Theyconclude that the motivation for these actions maybe driven by the possibility that certain firmshave profitable projects for which they cannot getfinancing. A merger with a larger firm can providethis financing. They theorize that once these projectsare financed, there arises ‘coordination costs’ due tolack of synergy in the conglomerate. It is thenbeneficial for the larger firm to divest the newlyfunded firm.

*Corresponding author. E-mail: Cjm29@pitt.edu

Applied Financial Economics ISSN 0960–3107 print/ISSN 1466–4305 online � 2007 Taylor & Francis 577http://www.tandf.co.uk/journalsDOI: 10.1080/09603100600722169

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Mitchell and Lehn (1990) investigate firms thatmake acquisitions. They focus on firms that makeacquisitions that reduce their equity value. Theypropose that there are ‘good’ takeovers and ‘bad’takeovers. They conclude that firms that make ‘bad’takeovers are more likely to become takeover targetsthemselves, and are more likely to divest. Theirresults show that firms that eventually divest have asignificant drop in stock price upon the announce-ment of the takeover. They conclude that thesedivestitures are ameliorations of ‘bad’ takeovers.

Kaplan and Weisbach (1992) study divestitures byfirms that had previously made acquisitions. Theycategorize divestitures as ‘successful’ or ‘unsuccessful’by the accounting gain or loss on the sale, descriptionby the business press article announcing the dives-titure and the divestiture sale price. They find thatbidder abnormal returns are lower for takeoversthat result in ‘unsuccessful’ divestitures than thosethat result in ‘successful’ divestitures. They also find agreater abnormal price increase on the divestitureannouncement for ‘successful’ divestitures than for‘unsuccessful’ ones. Their results suggest that not alldivestitures after acquisitions are the result of failedtakeovers.

Allen et al. (1995) investigate the correction-of-a-mistake hypothesis for spinoffs after acquisitions.They find that the abnormal return on the announce-ment of takeovers that result in spinoffs to biddingfirms is negative. They find that the combined marketvalue change of the bidder and target firms isnegative. They also find negative correlation betweenspinoff gains and takeover losses in these firms.However, they find no significant difference in gainsto spinoffs of prior acquisitions and spinoffs thatdidn’t result from acquisitions. They conclude thatnot all gains in spinoffs are the result of badacquisitions and that managers who make badacquisitions can partially ameliorate the problem bydivesting.

In this article, we further investigate thesetakeover-divestitures. We characterize the combina-tion of the two transactions as if they are two parts ofa more elaborate transaction, which we will call a flip.Our focus is on the wealth effects for firms thatundertake these flip transactions. We use the abnor-mal wealth effect associated with flips to assesswhether these takeovers are mistakes, or if theyprovide net positive value to the firms that initiate thetransaction. Additionally, we conduct further analy-sis to provide insight as to what characteristics oftarget firms lead to value enhancement in theacquiring firm.

Our methodology is similar to prior work inthat we concentrate on the market value change

on announcement of takeovers and divestitures.We differ from previous studies by concentrating onthe market value of the bidder firm and investigatingthe total wealth effect of the combined takeover-divestiture event. We concentrate on the bidder firmbecause that is the one that initiates the action.We investigate the combined market value change,because that is the total impact on the wealth of theshareholders of the bidding firm. If the total effect ispositive, then the shareholders are better off overalland we conclude the action was beneficial to them.If the total effect is negative, then the shareholdersare worse off overall, and we conclude that thebidding firm managers made a mistake.

It is likely that the market is not fully aware of thetrue intent of the bidding firm managers at the time oftakeover. The managers do not announce that theyintend to spin the target firm off in the future, so it islikely that the market views the announcement of thetakeover the same as any takeover and will bidthe price up or down based on that perception.The eventual spinoff would then be a surprise with aseparate market reaction to that event. If there isvalue in the takeover–divestiture combination wewould see a positive combined market value changeof these two events.

We make the additional contribution of investigat-ing what characteristics of the target firms lead tooverall positive market value changes. This inquiry isbeneficial for academics by providing empiricalevidence to test a theory. It is beneficial to practi-tioners by providing information for managersregarding what to look for in potential takeovertargets.

We measure abnormal returns on the announce-ments of the takeovers and divestitures. First, wecompute the abnormal market value change of thebidder firm upon the takeover. These bidder firms arethen characterized as parent firms in subsequentdivestitures. We compute the abnormal market valuechange of these parent firms when they undertakedivestitures. We calculate the ‘round-trip’ marketvalue change as the sum of the market value changeassociated with the takeover and subsequent dives-titure announcements.

We hypothesize that ‘mistake’ takeovers thatare ameliorated by the divestitures will result insignificantly negative market value change for theround-trip transaction. A significantly positiveround-trip market value change would indicate thatthe takeover flips are good for the acquiring firm.A nonsignificant market value change would indicatethat, on average, they are inconsequential.

Our results on the abnormal returns for bidderson acquisitions that are eventually divested are

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consistent in sign, magnitude and significance withthe findings reported by Mitchell and Lehn (1990),

Kaplan and Weisbach (1992) and Allen et al. (1995).For the target firms our results for abnormal returnsare consistent with Kaplan and Weisbach (1992) andAllen et al. (1995) in sign and significance, but oflesser magnitude than Kaplan and Weisbach (1992)

and greater magnitude than Allen et al. (1995).Our findings for abnormal returns upon divestitureare consistent in sign, but of less magnitude andsignificance than Kaplan and Weisbach (1992),and consistent in sign, significance and magnitude

with Allen et al. (1995). Overall, the abnormalreturns associated with acquisitions and divestituresfor our sample of firms are quite similar to the earlierstudies.

The combined round-trip market value changeassociated with these flips is not significantly differentthan zero. This evidence indicates that some of the

flips create wealth for the acquirer and some destroywealth. Further inquiry reveals that the level ofresearch and development (R&D) expenditures by thetarget firm is related to round-trip wealth gains ofparent-firm shareholders. These results are consistent

with the theory of Fluck and Lynch (1999), thattakeover-divestiture combinations can be valueenhancing when the target firm has profitableopportunities that can be funded by the acquirerwho then divests the firm when it has realized these

opportunities.

II. Data and Methodology

Hypotheses and methodology

We proceed with our empirical analysis in two steps.First we explore theories about takeovers followed bydivestitures proposed in previous studies. We com-

pute the effect the events have on the market value ofthe acquiring firm. We use the round-trip abnormalmarket value change to provide information onwhether these events are mistakes or if there is a netbenefit to the acquiring firm. If these events are

takeovers that are mistakes ameliorated by divesti-ture, we should see a significant negative value for theround-trip change in value. On the other hand, asignificant positive number indicates that these take-over flips are, overall, a benefit to the acquiring firms.

An insignificant value would provide inconclusiveevidence as to whether either of these theories canexplain takeovers that subsequently result in adivestiture.

The second step of the analysis is to determinewhat characteristics of target firms are associatedwith good or bad flips. We provide one mainhypothesis and several associated explanations as tohow the acquiring firm can potentially enhance valuethrough these actions. We test these hypotheses usingregression analysis of the round-trip market valuechange on accounting and financial variables of thetarget firms.

We derive our main hypothesis from the theoryexpounded by Fluck and Lynch (1999). This theorysuggests that flips can be beneficial to the acquiringfirm if they entail acquisition of a firm that hasgrowth opportunities for which it cannot obtainfinancing. The acquiring firm can fund these growthopportunities and divest once the subsidiary hascapitalized on the opportunities, with the acquirerenjoying the wealth created. There are three necessaryconditions for Fluck and Lynch’s (1999) model. Thefirst condition is that the target firm has growthopportunities. The second is that the bidder firm hasopportunities to obtain financing that the target doesnot. The third is that there is lack of synergy betweenthe bidder and target firms.

We begin by investigating if the second and thirdconditions hold for our sample. We test for adifference in the ability to attract financing bycomparing S&P credit rating for the bidder andtarget firms. If the bidder firms have a significantlybetter credit rating than the targets, we conclude thatthere is a difference in the firm’s ability to attractfinancing. Lack of synergy can arise in the combinedfirm if the bidder is in a different industry than thetarget. We compare SIC of the bidder and target firmin each takeover-divestiture event. If these eventsoccur predominantly between firms in different SICs,we conclude that synergy problems are likely in thecombined firm. Then, we perform regressions usingR&D expenditure as a proxy for growth opportu-nities in the target firm. We hypothesize a positiverelation between round-trip market value change ofthe acquirer and R&D expenditure in the target firm.

We also propose alternative hypotheses relating topotential sources of value to the acquiring firm. Thesehypotheses pertain not to value creation in the target,but value extraction from the target, with the acquirerdivesting once extraction is complete. We hypothesizeseveral potential sources of value that can beextracted by an acquirer and use accounting variablesto characterize them. We hypothesize a positiverelation between round-trip market value changeand these variables.

There are several possible reasons to motivate afirm to acquire and then divest another firm otherthan the presence of growth opportunities. Perhaps

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the acquirer seeks the target’s current income.A target may be attractive because it has income inbusiness areas or from relationships with clientsdifferent from that of the acquirer. Once the acquirerhas captured these business lines and relationships,it can jettison the unneeded portions of the target.We use net income and earnings per share for thetarget firms alternately in our models as variables tocapture this income-seeking motive.

A takeover may also be initiated as a means tocapture income from unfilled orders the target hasrecorded but not filled. A small target firm may havesales commitments that it does not have the resourcesto meet. This could jeopardize the revenues fromthese sales, thereby creating the need for a suitor.A larger firm with greater resources and well-developed delivery systems can intervene, take overthe small firm and realize the future cash flows andthen divest the target firm. We use order backlog as aproxy for the presence of unfilled orders.

Potential tax benefits provide a third possibleexplanation for acquisitions that result in subsequentdivestitures. A target firm in financial distress thathas sustained losses in prior years may have a tax losscarry-forward, which it can use to offset futureincome for tax purposes. If the firm eventuallygoes bankrupt, this tax benefit will never be realized.A financially sound firm that anticipates incomein future years may find greater value in thiscarryforward than the firm with less likelihood offuture income. Such financially sound firms canbenefit by acquiring firms with loss carry-forward.Once the acquiring firm has captured the loss carry-forward and has no further need for the target firm,a divesture follows. Tax loss carry-forward is thethird variable we incorporate in the analysis.

Sample selection

To develop the sample, we selected firms from theMergers & Acquisitions Database maintained bySecurities Data Company Inc. All merger andacquisition announcements during the period1 January 1980 to 12 December 1992 valued at $100million or more for nonfinancial US based firms wereconsidered. Next, we imposed the condition that theacquiring firm owns between 75 and 100% of thetarget firm after the transaction was completed. Weidentify spinoffs carried out by the acquiring firmssubsequent to the acquisitions from a spinoff databasemaintained by Security Data Corporation for theperiod between 1 January 1980 and 7 January 1998.The sample selection period for the spinoffs extendsbeyond that for the mergers and acquisitions, becausewe are interested in identifying spinoffs that are

related to an earlier merger or acquisition. The highlevel of merger and acquisition activity during theeighties was a major factor in the selection of thesample period.

The filtering process we employed resulted in asample of 79 acquisitions and 69 spinoffs orche-strated by 59 acquisition firms. The numbers differbecause some firms made multiple takeovers andsome firms made multiple spinoffs during the period.Eleven firms engaged in two takeovers, three firmsengaged in three takeovers and one firm engaged infour takeovers. Five firms made two spinoffs, onefirm made three spinoffs and one firm made fourspinoffs.

This sample was further reduced by the require-ment that there be adequate information in the CRSPand COMPUSTAT databases during the periodbeginning one year before the takeover to one yearafter the spinoff. This resulted in a final sample of70 acquisitions matched with 58 spinoffs.

Data collection

We collected data for a 3-year period that extendsfrom 1 year before to 1 year after the announce-ment of takeover for the bidder and target firms.We do the same for the parent firms around thedivestiture announcement. We collect data forthe spun-off ‘daughter’ firms in the year after thedivestiture announcement. We gather stock price datafrom CRSP and accounting data relevant to theproposed hypotheses from COMPUSTAT. CRSPdata include stock price and daily returns for eachof the firms as well as returns for the CRSP value-weighted index. Accounting data include general firmcharacteristic information: sales, number of sharesoutstanding and book value of equity as well ascharacteristics relevant to our hypotheses: netincome, earnings per share, order backlog, losscarry-forward and research & developmentexpenditures.

The price and return data from CRSP are used tocompute abnormal stock returns upon the announce-ment of takeovers and divestitures. We use themarket model to estimate expected returns for thefirms on the announcement day. We use the CRSPvalue-weighted index as a proxy for the marketduring an estimation period that extends from 200 to50 days prior to the event day. We calculate theabnormal return as the actual return for the samplefirm minus the expected return predicted by themodel generated during the estimation period.We use the abnormal return for all firms in thesample to determine the significance of the event.We also compute the total market value change

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associated with each event by multiplying theabnormal return upon announcement by the marketvalue (number of shares outstanding multiplied byshare price) on the first day of the estimation period.We find the ‘round-trip’ market value change bysumming the abnormal market value changes for alltakeovers and divestitures for each acquiring firm.For the analysis involving ‘round-trip’ market valuechange, we were restrained to a smaller samplebecause some firms did not have accounting dataduring both the takeover and the spinoff periods.We dropped all firms with missing data during eitherperiod.

For the purpose of the round-trip market valuechange, we treat all takeovers and spinoffs for eachindividual acquirer as one round-trip event. For firmsthat have multiple takeovers and/or spinoffs, we sumthe market value changes for all takeovers and allspinoffs to develop the round-trip market valuechange variable.

We also create several variables relating to thesituation of multiple takeovers and spinoffs for eachbidder and parent firm to investigate if multipletakeovers and spinoffs have an impact on shareholderwealth. We formulate one variable that is the numberof takeovers initiated by each firm. We create anothervariable that is the number of spinoffs. Finally we usethree dummy variables, the first set equal to one if afirm engaged in multiple takeovers and zero other-wise, the second is equal to one if a firm engaged inmultiple spinoffs and zero otherwise and the thirdis set equal to one if the firm engaged in multipletakeovers or multiple spinoffs and zero otherwise.We estimate several specifications of the regressionmodel using the different variables that control forany effects multiple takeovers and spinoffs may have.

In developing the sample, we conjectured that thetransactions were flips because the divestiture tookplace within a short time after the acquisition.Notwithstanding the selection criteria, the variationin the length of the period between the acquisitionand divestiture may still provide some indication onwhether these were planned transactions. Therefore,the time (in days) elapsed between the takeover andthe divestiture is included in the model as a variableto account for these effects.

III. Results

Sample statistics

Table 1 presents mean values of the accountingvariables for the bidder and target firms in the year

prior to the takeover announcement and for theparent and daughter firms in the year after theannouncement of the divestiture. The bidder firms aremuch larger than the targets in terms of sales andbook value as are the parent firms compared tothe daughters. The target firms are marginallyprofitable but have substantial order backlog andloss carry-forward. The bidder firms have strongprofitability and very low loss carry-forward andorder backlog. It appears that most of the loss carry-forward and order backlog are retained by the parentfirms after they spin off the daughter firms. We seea higher combined book value for the parent anddaughter firms than for the bidder and target firms.The parent firms have a dramatically greaternumber of shares than the bidder firms, indicatingissuance of shares after the takeovers. The largernumber of shares for parent firms may also be drivenin part by new shares issued to pay for theacquisition. There is a considerably higher level ofR&D expenditures in the daughter firms than in thetarget firms.

Industry summary

We collected the four digit SIC for each of our bidderand target firms for two purposes. The first reasonwas to compare the SIC’s among the target firms andamong the bidder firms to assess whether flips wereconcentrated in specific industries. Among the targetfirms, three firms were in the 5122 code and 2 firmseach in 2750, 2844, 3533, 3612, 3826, 3949 and 4213.All the other target firms were represented by unique4-digit SIC codes. The bidder firms presented asimilar picture, five firms were in 1311, three in 2834,two firms each in 3571, 4011, 4813, 4841 and 4922;with all other firms associated with unique SIC codes.With no evidence of industry clustering among thetargets and the bidders, industry effects cannot be afactor in our sample.

Next, we compare the industry of each bidder tothe industry of its corresponding target to assesswhether industry synergy contributed to the occur-rence of flips. Comparing bidders to targets, we seethat the bidder firm has the same 4-digit code asthe target in only two cases. There are no 3-digitmatches, two 2-digit matches and three 1-digitmatches. This evidence indicates that these flipspredominantly involved bidder and target firmsfrom different industries.

Financing opportunities

Table 2 presents evidence on the availability offinancing for bidder and target firms. We use the

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Table

1.Summary

statisticsanddifference

ofmeanstestsare

provided

forbidder,target,parentandspun-off

‘daughter’firm

s

Variable

Bidder

Target

Parent

Daughter

PanelA:Data

forbidder

andtarget

firm

sare

fortheyearbefore

takeover.Data

forparentanddaughterfirm

sare

fortheyearafter

thedivestiture.Thedollarfiguresare

inmillionsofdollars

exceptforEPS.Thenumber

ofsharesisin

millions.Thedollarfiguresare

inmillionsofdollars

exceptforEPS.Thenumber

ofsharesisin

millions

Sales

$5717.9

$792.6

$3056.4

$1001.3

Bookvalue

$1968.9

$280.0

$2897.5

$623.3

Net

income

$336.2

$20.9

$293.9

$36.7

EPS

$2.62

$1.11

$1.10

$0.015

Order

backlog

$0.17

$98.2

$121.4

$71.4

Loss

carry-forw

ard

$7.16

$30.1

$49.3

$3.68

Sharesoutstanding

59.6

21.1

198.8

22.4

R&D

expenditure

$94.7

$16.8

$118.1

$48.9

Variable

Bidder–Parent

Bidder–Target

Parent–Daughter

Target–Daughter

Panel

B:Difference

inmeansT-statisticsandp-values

(inparentheses)forthetest

ofsignificance

betweenpairsofvalues

forthefinancialvariablespresentedin

Panel

A

Sales

1.34

(0.1848)

4.07***

(0.0001)

�5.72***

(0.0001)

0.58

(0.5623)

Bookvalue

�1.88*

(0.0635)

4.61***

(0.0001)

�4.19***

(0.0001)

1.63

(0.1050)

Net

income

�0.03

(0.9768)

4.10***

(0.0001)

�2.29**

(0.0242)

0.63

(0.5297)

EPS

2.58**

(0.0114)

3.03***

(0.0030)

�1.50

(0.1373)

�1.51

(0.1332)

Order

backlog

�1.79*

(0.0859)

�1.11

(0.2706)

�1.94*

(0.0557)

�0.49

(0.6237)

Loss

carry-forw

ard

�1.83*

(0.0715)

�1.17

(0.2443)

�2.25**

(0.0268)

�1.67*

(0.0978)

Sharesoutstanding

�3.99***

(0.0001)

5.43***

(0.0001)

�4.68***

(0.0001)

0.04

(0.9667)

R&D

expenditure

�0.30

(0.7666)

5.34***

(0.0001)

�2.17**

(0.0327)

0.69

(0.4920)

Notes:*Significantatthe10%

level;**Significantatthe5%

level;***Significantatthe1%

level.

582 C. J. Marquette and T. G. E. Williams

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presence of an S&P credit rating and the quality of

that rating as an indication of each firm’s access to

financing. The table shows that forty-six of the 57 or

80.7% of the bidders firms were rated by S&P and

that 17 or 25.4% of the target firms were rated by

S&P. The proportion of bidder firms with an S&P

rating is significantly greater than the proportion for

the target firms at the 1% level.Using the numbering convention of COMPUSTAT

that attaches a number from 2 to 27 for credit ratings

ranging from AAA to D, we assign appropriate

numbers that reflect the credit quality of each firm

that has an S&P rating. The bidder firms that were

rated had a mean credit score rating of 10.7 (between

BBBþ and BBB) and the target firms that were rated

had amean credit score rating of 14.3 (between BB and

BB�). The difference is significant at the 1% level,

which indicates that the bidder firms that were rated

had a better mean credit score rating.In summary, the bidder firms had both a sig-

nificantly higher number of firms that were rated by

S&P and a significantly higher mean credit score

rating among the firms that were rated. Therefore,we conclude that the bidder firms had a better accessto financing than did target firms.

Announcement wealth effects

In Table 3, we report the abnormal stock returns tothe bidder and target firms on announcement of thetakeover as well as the abnormal returns for theparent firms on announcement of the divestiture.We also compute, for comparison with prior studies,announcement abnormal returns for target firms,which turns out to be significantly positive for allevent windows. Our results show that bidderslose value upon announcement of takeover. Thesefindings are consistent with past studies.

For the parent firms, the abnormal returns onannouncement of divestiture are positive but lesspronounced with significant wealth gains concen-trated from the date of the announcement to the dayafter. It is interesting to note that the response to thedivestiture announcement occurs only after theannouncement; indicating that the market did notanticipate the divestitures.

We compute the round-trip market value changefor each window using the same window for thebidder and parent announcements. For example,we combine the (�5, 5) window market valuechange for the bidder with the (�5, 5) value for thecorresponding parent firm. We do this for each eventwindow specification. The market value change foreach event is calculated as the abnormal return inthe event window multiplied by the total marketcapitalization of the firm. The market capitalizationis the stock price multiplied by the total number ofshares outstanding on that date. We use the priceof the stock and number of shares at the beginning ofthe estimation period for each event to calculate themarket value of the firm.

The round-trip market value change variable,reported in Table 4, is not significantly differentfrom zero for any of the event windows. These resultsindicate that, overall, these flips do not add value to

Table 3. Announcement abnormal returns for bidder and target firms upon takeover and for parent firms upon divestiture

Event window

Firm type (�5, 5) (�1, 1) (�1, 0) (0, 1)

Bidder �2.31** (0.0332) �2.04*** (0.0042) �1.78*** (0.0034) �1.77** (0.0126)Target 19.28*** (0.0001) 15.96*** (0.0001) 14.41*** (0.0001) 15.36*** (0.0001)Parent 0.37 (0.9257) 1.35* (0.0741) 0.13 (0.7051) 1.37** (0.0260)

Notes: *Significant at the 10% level; **Significant at the 5% level; ***Significant at the 1% level.The p-values are in parentheses.

Table 2. A summary of the access to financing for sample

firms as depicted by the presence of a S&P credit rating and

the quality of that rating

Description Bidder Target

Total number of firms 57 67Number of firms with S&P

credit rating47 17

Proportion of firms with S&Pcredit rating

80.7% 25.4%a

Mean credit rating score 10.7 14.3b

Notes: aIndicates that the proportion of bidder firms withS&P credit rating is significantly greater ( p-value of 0.001)than that for target firms.bIndicates that the mean credit rating score for bidder firmsis significantly lower ( p-value of 0.002) than that for targetfirms.The crediting rating score uses the COMPUSTAT numberconvention with 2 representing the highest credit rating ofAAA and 27 representing a D credit rating. Smaller meancredit rating score indicates a higher credit rating.

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or detract value from the acquiring firms. Theimplication is that either these transactions areinconsequential or that some are good and some arebad for the acquiring firm.

Multivariate tests

We conduct further analysis of the round-trip marketvalue change variable in conjunction with variablesthat characterize the target firms to assess whetherthere is any difference between ‘good’ flips and ‘bad’flips. For the multivariate tests we use the marketvalue change for the (�1, 1) event window.

First, we separate the sample into two groups, onewhere the market value change variable for the bidderis positive and the other where it is negative, and thencompare the average value of the selected financialvariables for the associated target firms in eachgroup. The results are reported in Table 5. There is nosignificant difference in any of the financial variablesfor the target firms. If a positive market valuechange is considered a ‘good’ flip and a negativemarket value change a ‘bad’ flip, then the financial

variables cannot distinguish between these twogroups of firms with respect to the characteristics ofthe target firms.

Next, we regress the round-trip market valuechange variable for the full sample on the financialvariables for the target firms. We run several modelspecifications but report the results for only two ofthese in Table 6. The R&D expenditure variableyields a positive and significant coefficient and thecoefficients for the other financial variables areinsignificant. The sign and significance of thecoefficient on the R&D variable is consistent acrossall the regressions, including those not reported. TheR-square for the model where R&D is the solevariable suggests that R&D expenditure can explainover 29% of the variation in the market value changeassociated with flips.

We re-estimated the regressions with the round-tripmarket value change as the dependent variable butinclude two additional variables. One a binaryvariable for multiple takeovers that is set equal toone for instances where there are multiple takeoversand zero otherwise and the other the number of

Table 5. Summary statistics for target firms that were taken over by bidders that had a positive

round-trip market value change and target firms of bidders that had a negative round-trip marketvalue change

VariablePositive marketvalue change

Negative marketvalue change

Differencepositive–negative

Round-trip marketvalue change

$628.4 �$159.6 $788.0*** (0.001)

Sales $793.8 $697.1 $96.7 (0.798)Book value $267.3 $267.2 $0.10 (0.999)Net income $31.7 $15.1 $16.6 (0.483)EPS $1.25 $1.04 $0.21 (0.728)Order backlog $117.0 $78.0 $39.0 (0.700)Loss carry-forward $7.82 $50.1 �$42.3 0.390)Shares outstanding 16.0 22.4 �6.4 (0.300)R&D expenditure $34.2 $8.8 $25.4 (0.209)

Notes: ***Significant at the 1% level.The dollar figures are in millions of dollars except for EPS. The number of shares is inmillions. Difference in means between the two samples is also included with the p-values(in parentheses) for test of significant difference.The round-trip market value change refers to the bidder firms while all the other figures referto the target firms.

Table 4. Round-trip market value change associated with the announcement of takeover and divestiture for bidder firm

Event window

(�5, 5) (�1, 1) (�1, 0) (0, 1)

Market value change round-trip �$172.8 (0.1767) $90.21 (0.3240) �$52.89 (0.4748) $81.97 (0.3366)

Notes: The p-values are in parentheses.The dollar figures are in millions of dollars.

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days between the acquisition and divestiture.The coefficient for the binary variable for multipletakeovers turns out to be positive and significant.This result is robust to all model specifications,including those where the number of takeovers is usedin place of the binary variable. The relationshipbetween the R&D variable and the round-trip marketvalue change remains intact when the multiple-takeover variable is included in the model.

Even though we show that R&D expenditure has apositive impact on the round-trip market valuechange, we cannot say whether the effect is capital-ized upon the takeover or the divestiture. To resolvethis question, we run two additional sets of regres-sions, one with the takeover market value change forthe bidder as the dependent variable and the otherwith the divestiture market value change for theparent as the dependent variable. The results arepresented in Table 7.

The estimated coefficient for the R&D variable isnot significant in the regression with the acquisitionannouncement market value change, but is significantat the 1% level in the regression of the divestiture

market value change. This finding indicates that theR&D effect is associated solely with the divestitureportion of the flip transactions. These results suggestthat the market either undervalues the growthopportunities of the target at the time of theacquisition or fails to anticipate the bidder’s intentionto capitalize on these opportunities. When thebidders’ actions become clear upon announcementof the divestiture, the market responds positively.

The only other variable that is significant in theseregressions is the order backlog variable. Theestimated coefficient for order backlog is significantlypositive (0.031 with p-value of 0.003) in the takeoverregressions and significantly negative (�0.51 withp-value of 0.06) in the divestiture regressions. Thereversal of sign on order backlog coefficient isconsistent with the insignificant result in the regres-sion models where the round-trip market valuechange is the dependent variable. The nonsignificantcoefficient for the order backlog variable reported inTable 6 seems to be the result of a cancelling out ofthe effects when we combine the acquisition anddivestiture market value change to get the dependent

Table 6. Regression results for round-trip market value change of the bidder on the financial characteristic variables for the target

firm. Panel A shows results without the variables for multiple takeovers and time elapsed between takeover and divestiture.

Panel B includes these variables

Model

Coefficients 1 2 3

Panel A: Results for the regression of the round-trip market value change on the financial characteristic variables of thetarget firms. The round-trip market value change is computed over the (�1, 1) event windowIntercept 460.51 (0.352) 490.74 (0.306) 55.66 (0.550)Log book value �76.68 (0.459) �86.56 (0.377)EPS �8.23 (0.886)Loss carry-forward �0.34 (0.597)Order backlog �0.22 (0.463) �0.22 (0.413)R&D expenditure 6.07*** (0.000) 5.97*** (0.000) 5.07*** (0.000)F-value 3.55** 6.10*** 16.55**R2 0.330 0.325 0.293

Panel B: Results for the regression of the round-trip market value change on the financial characteristic variables for thetarget firm, a multiple takeover variable and a variable that measures the length of time (in days) between an acquisition andthe subsequent divestiture. The multiple takeover variable is set equal to one, where the bidder firm is involved in multipletakeovers and equal to zero if only one takeoverIntercept 556.01 (0.364) 459.58 (0.317) �74.41 (0.520)Log book value �110.16 (0.316) �111.79 (0.231)EPS 1.79 (0.974)Loss carry-forward �0.41 (0.528)Order backlog �0.20 (0.490)R&D expenditure 5.72*** (0.000) 5.50*** (0.000) 4.69*** (0.000)Multiple takeovers 382.72* (0.059) 334.69* (0.064) 322.13* (0.075)Time between takeover

and divestiture�0.05 (0.628)

F-value 3.22*** 7.53*** 10.43***R2 0.398 0.373 0.348

Notes: *Significant at the 10% level; **Significant at the 5% level; ***Significant at the 1% level.The p-values are in parentheses.

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variable for the flip transactions. This result indicatesthat the market favours takeovers where it seesextractive opportunities, but in the long run, thesetakeovers are not beneficial overall.

IV. Conclusions

We provide evidence on the efficacy of takeover-divestiture combinations. There is no consistentevidence that these takeovers either benefit share-holders or destroy wealth. However, there is asignificant positive relationship between the marketvalue change for flips and R&D expenditures in thetarget firm.

These results are consistent with the theory of Fluckand Lynch (1999), which suggests that these transac-tions can be value enhancing when a firm with betteraccess to capital acquires another firm with growthopportunities and divests once those opportunitieshave been realized. In addition, the results havepractical implications for managers of firms with goodcredit ratings, indicating these firms can enhanceshareholder value by targeting firms with growthopportunities and limited access to financing.

The evidence from our sample does not supportmany of the several other plausible motives we

conjectured for firms to engage in takeover-divestiture activities. However, the prevalence ofthese activities suggests opportunities for furtherinquiry of the firms involved and the circumstancessurrounding takeovers that are followed by subse-quent divestures.

References

Allen, J. W., Lummer, S. L., McConnell, J. J. andReed, D. K. (1995) Can takeover losses explain spinoffgains?, Journal of Financial and Quantitative Analysis,30, 465–85.

Daley, L., Mehrotra, V. and Sivakumar, R. (1997)Corporate focus and value creation: evidence fromspinoffs, Journal of Financial Economics, 45, 257–81.

Fluck, Z. and Lynch, A. W. (1999) Why do firmsmerge and then divest? A theory of financial synergy,Journal of Business, 72, 319–47.

Hite, G. and Owers, J. (1983) Security pricereactions around corporate spinoff announcements,Journal of Financial Economics, 12, 409–36.

Kaplan, S. N. and Weisbach, M. S. (1992) The success ofacquisitions: evidence from divestitures, Journal ofFinance, 47, 107–38.

Miles, J. A. and Rosenfeld, J. D. (1983) The effect ofvoluntary spinoff announcements on shareholderwealth, Journal of Finance, 38, 1597–606.

Mitchell, M. and Lehn, K. (1990) Do bad bidders becomegood targets?, Journal of Political Economy, 98, 372–98.

Table 7. Regression results of acquisition and divestiture market value change of the bidder on financial characteristic variables

for the target. Panel A shows results for the acquisition and Panel B shows results for the divestiture.

Model

Coefficients 1 2 3

Panel A: Regression results for several model specifications of the acquisition market value change of bidder firms on thefinancial characteristic variables for the target firmsIntercept 337.40** (0.034) 331.57** (0.022) 287.98** (0.043)Log book value �84.74** (0.011) �84.23*** (0.005) �72.91** (0.012)EPS �4.28 (0.785)Loss carry-forward 0.26 (0.221) 0.29 (0.128)Order backlog 0.31*** (0.003) 0.28*** (0.002) 0.28*** (0.003)R&D expenditure 0.08 (0.884)F-value 3.08** 5.34*** 6.61***R2 0.264 0.263 0.223

Panel B: Regression results for the divestiture market value change of parent firms on the financial characteristic variables forthe target firmsIntercept 199.76 (0.632) 133.45Log book value �10.26 (0.904)EPS �1.34 (0.979)Loss carry-forward �0.53 (0.347)Order backlog �0.51* (0.060) �0.50** (0.038)R&D expenditure 6.05*** (0.000) 5.83*** (0.000)F-value 5.25*** 13.24***R2 0.408 0.393

Notes: *Significant at the 10% level; **Significant at the 5% level; ***Significant at the 1% level.The p-values are in parentheses.

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