2005.6.28
Seminar Title: Segment Profitability, Misvaluation, and Corporate Divestment
Time: 15:30-17:00 , Tuesday, June 28, 2005
Language: English
Speaker: Guochang Zhang of Hong Kong University of Science and Technology

Paper Abstract: This paper offers a theoretical explanation for corporate divestment in the context of accounting-based valuation and provides empirical evidence on the theoretical predictions. Applying a real-options based valuation model, we explain why firms with multiple business segments may have incentives in financial reporting to shift earnings from one segment to another to influence market valuation. Cross-segment earnings shifting, however, causes information asymmetry about segmental performances, which leads to market misvaluation. Divestment arises as a voluntary commitment by (some) firms to not engaging in segmental earnings manipulation, aimed to restore valuation accuracy. The theoretical analysis yields a number of testable implications. Consistent with the theoretical predictions, we find the following empirical results: i) divestment is preceded by an increased divergence of profitability between the divested and continuing segments of the divesting firm, ii) the abnormal stock returns surrounding divestment announcements are on average significantly positive, and positive market reactions are not followed by improved operating performances subsequently, iii) the magnitude of market revaluation increases with profitability divergence between the divested and continuing segments, and iv) market revaluation is greater for more complex firms (in terms of having more segments and greater uncertainty faced by investors).