With big corporate mergers and acquisitions getting topline attention, it seems counterintuitive for companies to divest as a way to grow. But a new book from Wharton management professor Emilie R. Feldman offers a comprehensive primer on divestitures, which can be a financial game-changer for companies that know how to execute them correctly.
Feldman, whose research focuses on corporate strategy and governance, spoke to Wharton Business Daily on SiriusXM about her book, “Divestitures: Creating Value Through Strategy, Structure, and Implementation,” which was released in December.
An edited transcript of the conversation follows.
Wharton Business Daily: What are the key themes in the book?
Emilie Feldman: The overarching message of the book is that there is an incredible amount of pressure for companies to expand and grow, often by mergers and acquisitions. But a lot of times, those strategies, and certainly the implementation of those strategies, are severely if not fatally flawed. What my work has shown is that often the idea of focus is overlooked by executives, and this is really the missed opportunity that could be pursued in the sense that divesting, removing assets and businesses that don’t fit and might be underperforming, could free up resources to pursue better opportunities in a more focused fashion after completion of those transactions.
Strategy refers to the different reasons why companies might pursue divestitures. I analyze four of them in the book: resolving or exiting underperforming businesses; improving focus; reconfiguring and reshaping the corporate portfolio to move into more profitable opportunities; and addressing regulatory requirements.
Structure refers to the different types of divestitures that companies could pursue. Sales are the most common, but spinoffs and other transactions could be utilized in different circumstances. And finally [there’s] implementation, which has to do with the nuts-and-bolts execution of these strategies and how companies actually put them into practice.
Wharton Business Daily: How common is it for business leaders to consider divestiture as an option?
Feldman: What my data show is that, on average, companies pursue two to three M&As for every one divestiture that they undertake. It’s double, nearly triple sometimes, on the M&A side relative to the divestiture side. Even worse, for example, if you look at the S&P 500, fully 70% of those companies never divest in any given year, and that’s true going all the way back to 2000. This is what I mean by the missed opportunity that companies almost don’t think about, that is the blind spot.
Again, if we look at value creation potential, the data show that, on average, divestitures create two to three times the shareholder value of M&As. I think that’s the pathology here, that companies and executives are pursuing exactly the wrong strategy when it comes to a shareholder value creation perspective.
“Managerial compensation is strongly correlated with market capitalization, so there’s a financial incentive not to divest because doing so reduces the executive’s bottom line.”— Emilie Feldman
Wharton Business Daily: Is that because divestiture is seen as a failure?
Feldman: I think that’s very true, although I think it highlights an important misconception about divestiture and the stigma that is often associated with these transactions. Divestitures are seen as, “OK, we bought something and it didn’t work out, so now we’re getting rid of it.” Or, “We pursued a strategy that didn’t pan out the way we anticipated, so we’re shifting gears.” In certain cases, that might be true. There could be circumstances in which companies do divest in response to failure. I’m not minimizing that.
But I think what’s important to recognize is there’s a whole world of thinking about divesting more proactively. “What could we be doing that we’re not doing because we’re holding on to this business, not because it’s underperforming or failing but just because we could to better things with our money, our time, our attention, our resources, our people?” Resources are finite within organizations, especially large organizations. The idea of being proactive has nothing to do with failure. I really see that the stigma that is often applied to divestitures — that they are a sign of weakness or failure — is misplaced in many circumstances.
Wharton Business Daily: Are there circumstances for which divestiture is the obvious answer?
Feldman: I think that’s what is quite challenging about these transactions as well, coming back to the inertia or reluctance to pursue them. Sometimes divestiture is the right answer and it’s clear, especially to external constituents like activist investors. But there are all of these organizational pressures that argue against doing these transactions. Managerial compensation is strongly correlated with market capitalization, so there’s a financial incentive not to divest because doing so reduces the executive’s bottom line. That could be one argument.
Oftentimes, we’ll hear, “If I divest, I’m going to have a huge tax bill.” Or “If I divest, I’m going to lose the cash cow that’s funding the rest of my operations.” Or “I can’t divest because this is the business that granddad founded 100 years ago and divesting would be emotionally costly to the family.” My point is there are often explanations or stories about why divesting can’t or shouldn’t happen, but a lot of times those stories simply aren’t true or there are ways to get around them. The inertia could be overcome, and the right answer — divesting — could be pursued. But the hurdle is really challenging for many companies.
“Perhaps once companies and executives begin to realize that this is a real source of value creation, that balance will shift a little bit and we’ll start to see more research.”— Emilie Feldman
Wharton Business Daily: What is the role of the activist investor in divestiture? What about general social pressure from consumers or the community?
Feldman: What we end up observing is that activist investors, in over a quarter of their campaigns, demand that companies divest. That’s pretty significant if you think about it. One of the main avenues of value creation that activist investors are proposing is [divestiture]. What my research has shown is that when companies follow these activist-driven recommendations to divest, those divestitures even outperform the average positive effects that I was talking about. The external pressure to pursue these transactions and overcome the organizational impediments that might be at play within companies is a huge source of value that can be attributed to activist investors.
You also raise an interesting point about social pressure. This is one area where I haven’t seen research, but it would be very interesting. Given the current environment where we see lots of social activism, does that drive divestiture decisions? Maybe I’ll shout out here on the research side to any academics thinking about topics to study.
Wharton Business Daily: What are the implications of your research in the academic setting?
Feldman: Much in the same way that we observe a prioritization of M&A over divestitures in terms of the transactions that companies pursue, if we look at the prevalence of research studies, I think the number is something like 150 over the past 10 years about M&As in the top academic journal Strategic Management Journal, compared to 20 or so on the divestiture side. Equally, we see this imbalance in the representation of divestitures from a research perspective. I think the two go hand in hand — the practice and the academic side. We don’t see it as much in practice, so maybe academics don’t study it as much in research, so ‘round and ‘round we go. But perhaps once companies and executives begin to realize that this is a real source of value creation, that balance will shift a little bit and we’ll start to see more research.
Wharton Business Daily: What are the expectations for a company wanting to implement a divestiture?
Feldman: The first part of implementation that could add value from a long-term perspective is the idea of reconfiguration. What are we doing that we are now getting rid of? And how does that cause us to reshape the existing structure? For example, the cost structure. What do we keep in terms of physical facilities? How do we manage shared resources with the business we are divesting?
“What divestitures can catalyze, especially in companies that are managing them well, is opportunities to rethink how resources are allocated within the company.”— Emilie Feldman
All of that is backward-looking in a sense that we are reconfiguring what we already have. But the second part, and this is the piece that’s more counterintuitive, is the forward-looking piece. What divestitures can catalyze, especially in companies that are managing them well, is opportunities to rethink how resources are allocated within the company. What could we be doing once we’ve gotten rid of this business? How are we freeing up resources that might help us pursue better opportunities? Should we rethink our resource allocation processes, how managers are spending their time and attention?
I think that’s one forward-looking aspect. The other is perception. We were the company that used to do X, and now we’ve gotten rid of the part of the business that was involved in that. How do we reshape how the rest of the world sees our company? The investment community, various stakeholders? Do we change the company’s name to try to manage perceptions? What other changes do we try to make to influence the way that the company is seen by external constituents? That forward-looking piece, I think, is a critical but overlooked part of the implementation process that my book touches on a great deal.
Fifty percent of companies that do divestitures change their name in conjunction with that transaction, which I think is an enormous number. But even further, the companies that change their names in conjunction with the divestiture outperform those that don’t change their name. Again, it’s this point of value creation. You can do the transaction and that’s great and on average will create value, but there’s a whole set of tools and tactics that you can pursue at the same time that can really amplify the value creation for these transactions.
Wharton Business Daily: Is it possible for business leaders to change their mindset on this topic?
Feldman: I think that’s exactly the right point and exactly the right word: mindset. Right now, we live in a world where these transactions too often are not considered, not even thought about, just not even on the table. It’s certainly not the message of the book that companies should always divest and this is a panacea that can be used in any situation. But rather, it’s the thought process. What is our portfolio? What is our strategy? What are we trying to accomplish as a company, and does the composition of business units that we have within our organization maximize our potential to create value for our shareholders, our investors? If the answer to that is “no,” at least we’re thinking about this tool that we can use to hopefully try to move in the right direction. I think that’s the real point of the book. It’s a shift in mindset and embracing [the work of getting] down to brass tacks: what strategy are we using, and how are we allocating resources to achieve that.