Active Asset Markets, Divestitures and Divisional Cross-Subsidization

33 Pages Posted: 16 May 2000

See all articles by Sudipto Dasgupta

Sudipto Dasgupta

Chinese University of Hong Kong, Lancaster University, and CEPR

Vidhan K. Goyal

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Guofu Tan

University of Southern California - Department of Economics

Date Written: April 2000

Abstract

This paper develops a model which shows that when divestiture activity takes place in the backdrop of an active asset market, divisional cross-subsidies emerge even in the absence of agency problems between managers and shareholders. In our model, the incentive to cross-subsidize arises because firms attempt to window-dress the performance of divisions that are likely candidates for sale. Since in equilibrium, the prospective buyers are not misled, window-dressing results in a deadweight loss. An early divestiture avoids this deadweight loss and consequently improves firm value. This theory of cross-subsidization is consistent with existing empirical results reporting value gains on asset sales and relating these gains to increases in focus. An additional empirical prediction of our model is that the performance improvement of the remaining divisions would be greater when assets are sold in periods of relatively high takeover activity in the divested unit?s industry. We test this prediction and find consistent results.

JEL Classification: G31, G34, M41

Suggested Citation

Dasgupta, Sudipto and Goyal, Vidhan K. and Tan, Guofu, Active Asset Markets, Divestitures and Divisional Cross-Subsidization (April 2000). Available at SSRN: https://ssrn.com/abstract=223208 or http://dx.doi.org/10.2139/ssrn.223208

Sudipto Dasgupta (Contact Author)

Chinese University of Hong Kong, Lancaster University, and CEPR ( email )

CUHK, Cheng Yu Tung Building, Room 1224
Shatin, NT
Hong Kong
Hong Kong

Vidhan K. Goyal

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong
852-2358-7678 (Phone)
852-2358-1749 (Fax)

HOME PAGE: http://www.vidhangoyal.com

Guofu Tan

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall, 300
Los Angeles, CA 90089
United States
213-740-3520 (Phone)

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