The significance of sell-off profitability in explaining the market reaction to divestiture announcements

Previous research on asset sales has emphasized the divestment motivation and the use of the proceeds from the sale as determinants of selling firm value gains. In contrast, this paper explores the extent to which the relevant information necessary to evaluate sell-offs is embodied in the profitability of the sale, i.e. the price received by the seller over the value-in-use of the divested assets, where the latter is a function of past operating earnings and book value. Our empirical results show that sell-off profitability is substantially more significant in explaining the market reaction to divestiture announcements than the previous literature has suggested. We provide strong evidence of a positive relation between selling firm abnormal returns during sell-off announcements and profit on the sale, which remains significant after controlling for the motivation behind the sell-off, the use of the proceeds from the sale and the presence of agency costs of managerial discretion. We conclude that sell-off profitability explains a major portion of selling firm abnormal returns and is one of the most significant determinants of the market reaction to divestiture announcements. (C) 2002 Elsevier Science B.V. All rights reserved.