Strategic Management Journal, Vol. 18, 77–83 (1997)

RESEARCH NOTES AND COMMUNICATIONS

AGENCY CONFLICT AND CORPORATE STRATEGY:

THE EFFECT OF DIVESTMENT ON CORPORATE

VALUE

PETER WRIGHTFogelman College of Business and Economics, University of Memphis, Memphis,Tennessee, U.S.A.

STEPHEN P. FERRISCollege of Business and Public Administration, University of Missouri—Columbia,Columbia, Missouri, U.S.A.

Among the various stakeholders of a firm, senior managers are the most likely targets forprivate and public political pressures. Other stakeholder groups are less visible and may beperceived as less influential in corporate strategy formulation and implementation. In somesituations, consequently, senior executives may adopt corporate strategies in response to politicalpressures even if these strategies may be costly to shareholders. In this study, a special caseis examined: the effect of divestment of South African business units on firm value. Using datafrom 1984 through 1990, we examine the impact that announcements of divestments have uponthe stock return behavior of publicly traded firms. Our results indicate that significant andnegative excess returns accrue to shares of companies announcing divestments of South Africanoperations. These results are supportive of the premise that noneconomic pressures mayinfluence managerial strategies rather than value-enhancement goals.

Valuable insights have been provided on the sub- 1970s and the 1980s have been examined. Rav-enscraft and Scherer (1987) conclude that manyject of corporate divestment from a variety of

perspectives. Earlier works concentrated on con- of the divestments in the 1970s and the 1980swere motivated by the underperformance of busi-tingencies which required divestments: in situ-

ations where a business unit drains resources from nesses acquired in the 1960s. Others report thata portion of acquisitions made in the 1970s andother, more profitable units (Salter and Weinhold,

1979), where the unit is not as efficient as alterna- the early 1980s were also unsatisfactory and oftendivested by the latter 1980s (Kaplan and Weis-tives in the marketplace (Dundas and Richardson,

1980; Williamson, 1975), or when the business back, 1990).Select authors have suggested that theis in its decline phase (Harrigan, 1979).

Divestment is also implied in cases where the underperformance of a number of corporationshas been due to the unrelatedness of their unitsunit’s interdependence with other units is not

synergistic or its competitive position is weak (Porter, 1987; Shleifer and Vishny, 1991). Inresponse, many of the takeovers in the 1980s(Greiner, 1972; Scott, 1973).

More recently, corporate divestments of the have been characterized as acquisitions whichwere followed by sell-offs of previously acquiredunrelated businesses (Shleifer and Vishny, 1991)or those leveraged takeovers by the managersKey words: agency theory; corporate divestment; cor-

porate performance; firm value themselves which were then pruned by substantial

CCC 0143–2095/97/010077–07 Received 17 November 1994 1997 by John Wiley & Sons, Ltd. Final revision received 28 August 1995

78 P. Wright and S. P. Ferris

sell-offs of assets (Bhagat, Shleifer, and Vishny, treatment of black South Africans by the minoritywhite South African government (Ennis and Par-1990; Kaplan, 1990).

The above studies have advanced our under- khill, 1986).Many of the proponents of divestment, how-standing of corporate divestments which are prim-

arily economically motivated. Other works have ever, failed to realize that a number of Americanbusiness interests in South Africa not only wereexamined corporate strategies in the context of

agent–principal relationships. Specifically, agency profitable, but also economically, politically, andsocially beneficial to black South Africanstheory has been explored via diversification,

reverse diversification, and downsizing strategies (Erasmus, 1994; Ford, 1994; Lashgari and Gant,1989). Some of the American firms had a record(e.g., Amihud, Lev, and Travlos, 1990; Bethel

and Liebeskind, 1993; Blackburn, Lang, and of equal pay for equal work and provided thebest desegregated working conditions in SouthJohnson, 1990; Bowman and Singh, 1993; Com-

ment and Jarrell, 1992; Franks, Harris, and Tit- Africa. Also, U.S. business and governmentgroups served as influential forces in reformingman, 1991; Singh, 1993). Our examination is an

extension of the agent–principal theory as applied the government of South Africa throughout the1980s and the early 1990s.to the issue of corporate divestment. The contri-

bution of this study, moreover, is that its focus In order to analyze the impact of divestmentannouncements of South African operations onis on another dimension of agency theory which

we have framed as our research question: ‘Do stock prices, an event study methodology isemployed. If divestment announcements are madeprivate and public political forces determine cor-

porate strategy?’ as a result of agency conflicts and are perceivedto be economically costly, firms’ stock pricesAccording to Jensen and Murphy (1990), cor-

porate strategies which increase (decrease) a should react negatively to such announcements.Alternatively, if such announcements are mot-firm’s market value by millions of dollars may

only marginally affect the financial benefits of ivated by value enhancement goals, the marketimpact of these announcements should be positivetop executives. Moreover, these authors conclude

that the incentives of top managers may be inde- for stock prices. That is, if the South Africanunit represents a negative net present valuependent of their performance. Consequently, they

argue that private and public political forces often investment, then its divestment announcementshould be received positively in the financialdrive managerial strategies rather than a goal of

value maximization. If the financial incentives of markets. Alternatively, if the financial marketsperceive that the reallocation of corporatetop executives are indeed independent of their

performance, top executives may tend to adopt resources from South Africa to other parts of theworld represent a net economic gain, divestmentstrategies which are beneficial to themselves even

if these strategies may be costly to other stake- announcements would again be positive news.We organize the remainder of this paper intoholders, particularly shareholders.

Similar to Jensen and Murphy (1990), we pre- several sections. In the following section, wepresent a literature review which leads to oursume that under some circumstances noneconomic

forces may influence corporate strategy. We focus hypothesis. Subsequently, we describe ourresearch methodology, more fully explaining ourour study on a special case: corporate divestments

of South African operations. More specifically, we process for sample construction and the detailsregarding our application of the event method-examine the impact that public announcements of

divestment of South African operations have on ology. Finally, we report our results and providea discussion of their interpretation.the stock return behavior of publicly traded firms

in the context of a principal–agent relationship.Prior to July 10, 1991, when it was announced

that all U.S. economic sanctions against SouthLITERATURE REVIEW ANDHYPOTHESISAfrica would end, there was a buildup of private

and public pressure to divest U.S. business inter-ests in that country (Erasmus, 1994; Ford, 1994). Shareholders prefer that senior managers adopt

corporate strategies which enhance firm value.The pressure to divest resulted from the moraloutrage that Americans felt in response to the Senior executives, however, may make decisions

Research Notes and Communications 79

based only upon a comparison of their personal A number of corporations announcingdivestments had good Sullivan ratings, whichgains and losses from pursuing a specific strategy

(Gomez-Mejia, Tosi, and Hinkin, 1987; Jensen imply that their operations were supportive of thecause of the black South Africans (Lashgari andand Meckling, 1976; Jensen and Murphy, 1990;

Kroll, Wright, and Theerathorn, 1993; Tosi and Gant, 1989). In this context, then, some of thedivestments may not only have been harmful toGomez-Mejia, 1989; Wrightet al., 1996).

Personal costs of conducting business in South shareholders, but they also may have been soci-ally irresponsible. The Sullivan ratings of cor-Africa for top executives could include the loss

of public image as a humane citizen, lack of porations operating in South Africa are traceableto the Sullivan principles. In 1977, a leadingsensitivity to the morally objectionable practice

of apartheid, ongoing political pressures from Philadelphia activist in the antiapartheid move-ment, the Reverend Leon Sullivan, formulated amembers of the community as well as threats of

media exploitation. It is conceivable, then, that code of conduct for U.S. companies active inSouth Africa.in the context of our study, management may

announce divestment of a South African operation Firms signing this code agreed to an acceptableminimum wage, equal opportunity for allfor personal reasons and in response to various

pressures. This is consistent with Jensen and Mur- employees, integrated work spaces and cafeterias,equal pay for equal work, training of blacks forphy’s (1990) contention that private and public

political forces may drive corporate strategy. technical and managerial jobs, and to increasethe number of blacks in management (Kaempfer,In some cases, divestment may be a result of

unprofitable South African business units. In other Lehman, and Lowenberg, 1987). Note should bemade that in their empirical investigation, Lash-cases, the reallocation of corporate resources from

South Africa to other projects might result in a gari and Gant (1989) have concluded that theaverage return on equity for those firms withnet gain. Thus, agency conflicts may not be able

to explain divestment decisions in such cases. good Sullivan ratings has not been diminished bytheir subscription to the Sullivan principles.The impact of these economically oriented

divestments on stock prices, however, should be In retrospect, it can be argued that the continu-ation of the U.S. government’s recognition of thepositive as unprofitable units are eliminated or

resources are utilized more efficiently. Note that South African government as well as the ongoingoperations of many U.S. businesses in that coun-we proxy business unit profitability as well as

the efficient utilization of resources via stock try were important forces in the reform and inthe termination of apartheid policies of the Southreturns because share prices represent expec-

tations of future financial prospects as opposed African government (Ford, 1994). Indeed, SouthAfrica had made such progress in the improve-to accounting returns which are primarily reflec-

tive of past performance. ment of its governance that on July 10, 1991President Bush announced the cessation of allAgency problems, however, may well exist in

other situations. We emphasize that, among the U.S. economic sanctions against that nation.Although noneconomic forces, operating bothvarious corporate stakeholder groups, senior man-

agers are the most likely targets for public and in the external environment and within organiza-tions, may be important determinants of corporateprivate pressures to divest South African oper-

ations. Other stakeholder groups, such as strategy, these forces are not easily subject todocumentation. This is true since such forcesemployees, suppliers, customers, or shareholders,

are less visible and may be perceived as less operate in informal and indirect ways. Becausesenior managers may have been the targets ofinfluential in corporate strategy formulation and

implementation. Consequently, these managers pressures to divest South African operations, theycould selfishly eliminate this personal disutilitycould eliminate such personally costly pressure

by divesting their South African business oper- by terminating their corporate business interestsin that country even if divestments are costlyations even though these units may be profitable,

representing the efficient utilization of corporate to shareholders.In the context of our discussion to this point,endowments. As is evident, the impact of

divestment of profitable units on stock prices we anticipate that divestment announcements ofSouth African business units by corporations mayshould be negative.

80 P. Wright and S. P. Ferris

have been motivated by noneconomic forces. as a proxy for whether firms are managed inresponse to public expectations (Dutton andThus, on average, these announcements may be

associated with a negative market response: Dukerich, 1991; Solomon and Hansen, 1985).Divestment of a business in South Africa withouta good Sullivan rating may have been motivatedHypothesis 1: Divestment announcements of

South African operations by corporations areby concerns for social responsibility as opposedto having been driven by agency conflict. Conse-associated with significant negative abnormal

returns accruing to their common stock. quently, by limiting the sample to divestments ofunits with good Sullivan ratings, we attemptedto control for the confounding effect of issueThis hypothesis is empirically tested in our study.

If the empirical results show that divestment management (Dutton and Duncan, 1987; Greeningand Gray, 1994).announcements of firms are associated with insig-

nificant returns or with positive excess returns Moreover, we perused annual reports, searchedthe Dow Jones News Retrieval as well as exam-accruing to stockholders, then we will conclude

that such divestments may not be due to agency ined indexes of theWall Street Journaland theNew York Timesto make sure that divestmentproblems. In this situation, our hypothesis must

be rejected. If divestment announcements are announcements studied were not forced on man-agement by shareholder resolutions. We searchedempirically associated with negative excess

returns, however, we may surmise that top man- these data sources also to ensure that divestmentswere not in response to lawsuits. Presumably, theagers might have acted on their own selfish inter-

ests which are costly to shareholders. The spe- management of corporations which did not facelawsuits or shareholder resolutions knew thatcifics of our methodology, which tests the above

hypothesis, are described below. other firms were confronted with these measures.It is conceivable, then, that the purpose of theirproactive withdrawal might have been to preemptbeing forced out of South Africa.SAMPLE AND METHODOLOGY

Nevertheless, in response, an argument may beSample constructionmade that the firms which proactively divestedmay subsequently not have been forced toFor the period January 1, 1984 through December

31, 1990, a total of 116 divestments are identified retrench. Indeed, even if confronted with share-holder resolutions or lawsuits, these firms mightthrough a search of the list compiled by the

Investor Responsibility Research Center (IRRC) have been able to delay—until the sanctionsagainst South Africa were lifted. Recall that thefor corporations departing from South Africa. The

reason for choosing this period of time for study ruling white minority government throughout themiddle and latter 1980s had declared that govern-is that in 1991 all U.S. economic sanctions were

officially ended against South Africa as a result ment in the 1990s would be determined by freeelections (axiomatically resulting in blackof that nation’s reforms and the end to apartheid

policies. Thus, the year 1990 is the last full year majority rule). Since the period of the studyprimarily encompasses the middle to the latterduring which time private and political pressure

would have been exerted on top managers to 1980s, it is possible to envision that managementmay have had the option to state that theydivest South African operations. Also, the IRRC

has maintained this list only since January 1, intended to divest within several years, if apart-heid policies were not eliminated. The final sam-1984; hence, data availability restricted our analy-

sis from examining years previous to 1984. ple, compatible with the above criteria, consistsof 31 firm announcements of divestment of SouthSelect firms are excluded from being in the

sample: if the actual event dates of firm African subsidiaries. These 31 firms are listed inTable 1.announcements are not available in theWall

Street Journalor the New York Timesindexesand/or if the firms are not publicly traded compa-Methodologynies. All of the studied divestment announcementswere made by corporations which held a good In order to examine the stock returns surrounding

the announcements of divestments, we apply theSullivan rating. We utilized the Sullivan rating

Research Notes and Communications 81

Table 1. List of firms included in sample contain information relevant to a firm’s futurefinancial performance.

Apple Computer Honeywell, Inc. As noted above, the actual daily rates of returnBank of Boston IBM

on the firm’s stock are adjusted for the expectedBundy Corp. ITT Corp.rate of return. The estimation of daily expectedChemical Bank Corp. Johnson Controls, Inc.

Citicorp Kodak rates of return for a stock is accomplished throughCoca Cola McGraw Hill use of the CAPM. The CAPM is an equilibriumCPC International, Inc. Merrill Lynch & Co. relationship between asset risk and return thatDow Chemical, Inc. Mobil Corp.

has been widely applied to equity behavior. TheDun & Bradstreet Norton Co.CAPM contends that investors must be compen-Emhart Corp. Raychem Corp.

Exxon Corp. Revlon Group, Inc. sated by higher rates of expected return in orderFirestone Tire Sara Lee to bear additional risk. The event methodologyFluor Corp. Tambrands, Inc. has been widely used in finance and strategicGeneral Motors Unisys Corp.

management. We should emphasize, however,Goodyear Tire Xerox Corp.that some observers have been critical of theHertz Corp.event methodology and its presumption of marketefficiency (Shleifer and Vishny, 1991).

RESULTS AND DISCUSSIONevent study methodology (Brown and Warner,1985; Famaet al., 1969). This method analyzesdaily equity rates of return over a period sur- In Table 2 we present the mean daily common

stock reactions for our sample of firms announc-rounding the specific event of interest. Theobserved daily rates of return, available from the ing divestments of South African business units.

On the event day (day 0), there is a significantCenter for Research in Security prices (CRSP)data base, are adjusted for the expected rates of and negative excess return of20.249 percent.

The statistically significant increase in the numberreturn, calculated according to the Capital AssetPricing Model (CAPM) (Sharpe, 1964). By sub- of negative excess returns on the announcement

day indicates that this is a widespread effecttracting the expected component of return fromthe observed rates of return, we are left with the rather than one driven by a few outliers. Our

estimation is supportive of the hypothesis of theexcess return which is that portion of returnattributable to firm-specific activity. These excess study.

The results of this study suggest that announce-returns are then cross-sectionally averaged acrossthe sample of corporations to obtain a mean ments of corporate divestment of South African

business units are associated with significantexcess return for the particular day in ourreporting window. negative excess returns. The contribution of our

examination is that it provides some evidenceIn this study, we report the mean unexpectedrate of return for 10 days prior to and 10 days which suggests that divestments of business units

in South Africa may have been motivated by thefollowing the announcement of divestment. Theparameters necessary to calculate the expected self-interests of senior managers and, as such,

represent the manifestation of an agency problem.return are estimated utilizing an estimation win-dow of day 2260 to day211, which provides These results are counter to the traditional

theory of the firm where it is assumed that organi-us with approximately a year’s worth of tradingactivity. Application of the event study method- zations are managed in the best interests of their

owners (Marris, 1964). Moreover, the results areology focuses on the pattern of daily stock ratesover a period surrounding the event of interest. not supportive of the premise that senior execu-

tives are motivated to act in the best interests ofThis allows one to determine if there is evidenceof information leakage prior to the event or a the shareholders as a result of: capital market

signals (Easterbrook, 1984; Rozeff, 1982), mana-lingering effect in the postevent period. Generally,the impact on shareholder wealth is focused on gerial labor markets (Fama, 1980), and the threat

of hostile takeovers (Manne, 1965; Martin andthe actual event day itself. This is because finan-cial markets are quick to respond to events that McConnell, 1991). Our study provides further

82 P. Wright and S. P. Ferris

Table 2. Excess stock returns surrounding the announcement of the divestiture of business operations

Number ofnegative excess Sample Binomial

Daily percentage Cumulative percentage returns size testEvent day excess rates of returnt-statistic excess rates of return N(2) N statistic

210 0.103 0.928 0.103 13 31 20.89829 20.178 20.781 20.075 14 31 20.53828 0.107 0.377 0.032 14 31 20.53827 0.099 0.561 0.131 15 31 20.17926 0.044 0.823 0.175 12 31 21.25725 20.218 20.340 20.043 14 31 20.53824 20.112 20.917 20.155 16 31 0.17923 20.094 20.069 20.249 13 31 20.89822 20.012 20.093 20.261 13 31 20.89821 0.142 1.057 20.119 17 31 0.5380 20.249 22.130* 20.368 23 31 2.694*

1 0.014 0.130 20.354 18 31 0.8982 0.111 1.122 20.243 13 31 20.8983 0.172 0.468 20.071 13 31 20.8984 20.108 20.523 20.179 12 31 21.2575 20.127 21.047 20.306 14 31 20.5386 20.144 20.928 20.450 13 31 20.8987 0.125 1.069 20.325 12 31 21.2578 20.187 21.081 20.512 15 31 20.1799 0.130 0.878 20.382 17 31 0.538

10 0.212 1.019 20.170 16 31 0.179

*p , 0.05.The binomial test statistic is calculated as:Z 5 [N(2)/N2(0.50)][(N/(.50)2)0.50].

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