Why Hang on to Losers? Divestitures and Takeovers



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    • J. L. Kellogg Graduate School of Management, Department of Finance, Northwestern University. The comments of seminar participants at Erasmus University, Rotterdam, CentER at Tilburg University (The Netherlands), Columbia University, Northwestern University, Tulane University, the Universities of British Columbia, Indiana, and North Carolina, and participants at the 1991 French Finance Association meeting in Louvain-La-Neuve and at the 1990 Western Finance Association meeting in Santa Barbara are gratefully acknowledged. The author thanks Sanjai Bhagat, Susan Chaplinsky, Mike Fishman, Ron Giammarino, David Hirshleifer, George Kanatas, Max Maksimovic, David Ravenscraft, Steve Raymar, Karl Schlag, René Stulz (the Editor) and two anonymous referees, and, especially, Anjan Thakor for detailed comments. Research assistance from Bill Emmons and Ron Simenauer is gratefully acknowledged. The usual disclaimer applies.


We study the divestiture decisions of managers who care about their reputations. Managers' divestiture and investment decisions are publicly observable, but managers privately observe signals with respect to the future payoff distribution of investments they have initiated. We establish that in equilibrium there is too little divestiture. These inefficiencies create the opportunity for wealth-enhancing divestiture-motivated takeovers. A key result is that only managers of targets with “middle of the road” asset specificity should consider the takeover threat credible. These findings suggest that uniqueness of assets is an important determinant of both agency costs and takeover activity. Our analysis leads to several empirical predictions.