When payout of disposal proceeds unlocks value: European evidence

Abstract

PURPOSE OF THE STUDY The thesis examines the use of cash proceeds following subsidiary disposals by European public companies. The purpose is to supplement the literature by determining whether there exists a trade-off between the investment efficiencies associated to retained proceeds, parallel to internal financing; and the agency costs of managerial discretion and debt, akin to one confirmed with research on U.S. data. In addition to applying Europe-wide data, the thesis studies the persistence of observed relations over time, which have not been conducted to date. Two approaches are utilised: first, the study tests whether the proxies associated with the trade-off are related to the likelihood of witnessing allocations between the firm and its claimholders; and second, the study measures cumulative abnormal returns to divesting firms around announcement, and tests whether the same proxies explain the cross-sectional variation in such returns.

DATA The data comprise 783 disposal events, market and accounting data, and the management’s stated use of proceeds for divesting firms. The events are sourced from mergers and acquisitions database of Thomson Financial. Selected transactions are subsidiary disposals completed between 1.1.1990 and 31.12.2007, implying a cash distribution of €50 million or more to the divesting firm. The market and accounting data are derived from Thomson Finacial’s Datastream and Worldscope. The use of proceeds are manually collected from the news and wire reports contained in LexisNexis database.

RESULTS Contrary to the U.S. evidence, the study finds no support for the efficiency standpoint, albeit both forms of agency costs gain support similar to the U.S. data. Four examples: first, cumulative abnormal returns are higher on average for firms that either pay a special dividend or announce share buybacks relative to firms that retain the proceeds or use them to cut debt; second, the tendency to retain increases with firm's cash flow across the whole period; third, excess of an industry investment is witnessed only with a set of financially unconstrained firms, indicating that pre-sale financial constraints do not drive retentions; and fourth, controlling for firm's coverage, the tendency to use proceeds for debt retirement or allocation to owners increases with excess of an industry leverage relative to retaining firms for 1990 – 1999, while the same tendency increases for firms cutting debt relative to both retaining firms and those disbursing proceeds to owners in 2000 – 2007. Key takeaway of the study is that there is strong support for the notion that a payout can unlock value, whereas the theory of retentions as value creative per cost efficiencies in financing remains a question unresolved.