Performance Before and After Discontinued Operations
68 Pages Posted: 16 Dec 2014
Date Written: December 15, 2014
Discontinuing an operation is a major decision for a manager, and requires approval from the board of directors. We provide valuable insights into these strategic choices. First, we document changes in reports of discontinued operations in recent decades. There is a major increase in divestitures after the implementation of new SFAS statements in 1998 and 2002. After the change in reporting requirements, the portion of firms discontinuing operations more than doubles in almost one-third of the industries that we analyze. Second, we use three multinominal logit models to determine the reasons for discontinuing an operation, and to gain insight into the signs and magnitudes of the reports. Three factors have the strongest effect on the decision. The firms that divest are unusually widely diversified, have high financial leverage, and have low values of Tobin’s Q. Undervalued firms are particularly likely to discontinue negative valued operations. Tightening corporate focus and improving performance seem to be very powerful motives for discontinuing an operation. Firms that divest often have also recently made large acquisitions, employ low levels of R&D and advertising, and slow historical sales growth. Finally, we examine operating efficiency after a discontinuation, and find evidence of marginal improvement in performance. Tobin’s Q rises, suggesting that markets approve. Revenue growth is better than for typical firms, and there is some evidence that operating profit margins improve. Overall, our results suggest that firms that discontinue an operation experience below average performance before, and improve marginally after, and markets reward them for these changes.
Keywords: Discontinued Operations, Firm Performance, Corporate Focus, Accounting
JEL Classification: G34, D22, M48
Suggested Citation: Suggested Citation