Market response to divestiture announcements: A screening theory perspective

Capital market investors have limited information about the motives, exchange terms, and expected outcomes of corporate divestitures. Thus, when a firm announces a divestiture, capital markets may have difficulty distinguishing divestitures that are likely to be beneficial and investment worthy from those that signify hidden problems. Drawing on screening theory, we argue that one way investors might overcome their information disadvantages is to use screens to identify investment-worthy divesting firms. We test this logic using one such screen: change in blockholding equity stakes prior to a divestiture announcement. Data from 858 European Union divestitures occurring in 13 Western European Countries show that investors' reaction to a divestiture announcement is positively associated with pre-divestiture changes in blockholdings in the divesting firm. Furthermore, investors' valuations were more positive in higher performing divesting firms that had increases in blockholding equity stakes before the divestiture than those that had reductions in these owners' equity stakes. The findings extend our understanding of how outsiders, such as investors, navigate incomplete information about divestitures. We describe how our study offers a range of implications for divestiture research.