The Divestiture Decision: The Business Judgment Rule and Other Legal Considerations
Posted: 15 Sep 1999
The decision of a firm to divest itself of a portion of its assets has important implications for economic efficiency. These implications have been examined extensively in the financial economics literature. One dimension of that decision that has been largely overlooked in this literature is the legal constraints placed on a firm's board of directors as it contemplates a divestiture transaction. We examine the important role played by the business judgment rule (BJR) and the limitations on its application to divestiture transactions. The BJR is especially important in the context of shareholder suits that may be brought subsequent to a divestiture decision. We also examine the protection and remedies open to creditors, and the much more limited remedies available to a firm's other stakeholders. We find that the BJR gives a firm's board of directors and managers broad latitude in making divestiture decisions. In order to invoke the legal protection implied in the BJR, directors must avoid making hasty or uninformed decisions, or placing their own interests or the interests of the corporation's officers, majority shareholders or controlling shareholders, or others before the interests of the corporation. We find that the rights of debtholders to sue in the event a divestiture adversely affects their economic interests in the firm are greatly limited. Other stakeholders in a divestiture have very limited legal protection.
JEL Classification: G3
Suggested Citation: Suggested Citation