  WHYANDHOWDOFIRMSDIVEST?           DISSERTATION   PresentedinPartialFulfillmentoftheRequirementsfor theDegreeDoctorofPhilosophyintheGraduate SchoolofTheOhioStateUniversity  By  NagaLakshmiDamaraju B.Sc.M.B.A.P.G.D.E.M.L.L.B.M.B.A.M.S.  *****   TheOhioStateUniversity 2008   DissertationCommittee:  ProfessorJayB.Barney,Adviser    Approvedby  ProfessorMichaelLeiblein            ProfessorAnilMakhija    _________________________   ProfessorSharonJamesAdviser BusinessAdministrationGraduateProgram                     Copyrightby NagaLakshmiDamaraju 2008                          ABSTRACT    Thisdissertationextendsandexaminestheimplicationsofrealoptionstheory—a theorythatdevelopedprimarilyinthecontextofinvestmentdecisions—inthecontextof divestmentofbusinessunits.Indoingso,itchallengessomeoftheexistingideasabout divestments—i.e.,thatfirms’unwillingnesstodivestmaybeduetoagencyreasonsor thatdivestmentsareareactiveresponsetopoorperformanceatparentand/orbusiness unitlevels.Further,alternativeexplanationsfordivestmentsanddivestmentmode choicesareconsideredalongwithexplanationsfromtherealoptionstheoryandthe relativeexplanatorypowerofrivaltheoriesisestablishedinthisseriesofthreeclosely- relatedessays.Allhypothesesaretestedonasampleofdivesting(298)andnon- divestingfirms(596)thathavebeenobtainedfromvarioussourcesfollowingprevious studies.  Thefirstessayshiftsthefocusofrealoptionstheoryfrominvestmentdecisionsto divestmentdecisions.Thekeyimplicationsofthetheoryaredevelopedandtestedfor businessunitdivestmentsas‘put’optionsonrealassets.Theresultsshowthat uncertaintyinabusinessunit’senvironmentisnegativelyrelatedwiththedecisionto divest.Further,thisnegativerelationshipremainswhenenvironmentaluncertainty increasesanddisappearswhenenvironmentaluncertaintyfalls.Together,theseresults ii   suggestthatfirms’decisionstodivestmaybedrivenbyoptionconsiderationswhenthe environmentofthebusinessunitisuncertain. Whilethefirstessayisaboutthedecisiontodivest,thesecondessayfollows closelyandisaboutdivestmentmodechoices.Inthesecondessay,therelative explanatorypowerofrealoptionstheoryandinformationasymmetryisexploredinthe contextofdivestmentmodechoices.Inparticular,itistestedwhetherstageddivestments aremorelikelyascomparedtosell-offsdueto1)uncertaintyinabusinessunit’s environmentand/or2)informationasymmetryaboutthetruevalueofthebusinessunit. Theresultsshowthatinformationasymmetryexplainsstageddivestmentswhereas uncertaintyisirrelevanttodivestmentmodechoicedecisions.Thisshowsthatwhile explanationsexistforstagedinvestmentsfromarealoptionsperspective,staged divestmentsdonotseemtofollowasimilarexplanation.Therefore,aseparate‘real optionstheoryofdivestments’maybeneeded,ratherthansimplyexpectingthe predictionsfrom‘realoptionstheoryofinvestments’toapplyinthecontextof divestments. Thethirdessayisalsorelatedtothefirsttwoessaysandfocusesontherelative impactsofdynamicchangesinuncertaintyandinformationasymmetryonthedecisionto divest,perse.Whilepriorstudieshaveexaminedexplanationsfromrealoptionstheory andinformationasymmetryseparately,therecouldbeaninterestinglinkagebetween thesetwotheoriesinthecontextofdivestments.Whiledynamicchangesinuncertainty havebeendealtwithinthefirstessay,inthethirdessaythedynamicchangesin informationasymmetryhavealsobeenconsideredtodelineatetheconditionswhere iii   optionsthinkingmayhaveadominatingeffectascomparedtoinformationasymmetry concerns.Resultssupportthetheoreticalpredictionthatoptionsconsiderations,under certainconditions,maydominateinformationasymmetryconcerns. Together,thesethreeessaysrepresentanimportantextensionofrealoptions theoryandimproveourunderstandingofthedivestmentphenomenon.                  iv                    DedicatedtotheUnionPublicServiceCommissionofIndiaforrejectingmein2001,the failurethatmademechangedirectionandembarkonthisyetanotherjourneyof excellence.Further,thisdissertationisalsodedicatedtothetaxpayersinIndiaandthe UnitedStateswhosemoneyshavebeenutilizedformyeducation.                         v      ACKNOWLEDGMENTS   Ithankmymother—myfirstteacherandangelinvestor,andmyfather—an uncompromisingperfectionistdisciplinarianwhowantsmetowinagainstalloddsatall times,whohavelaidfoundationformypersonalityandaspirations.Ilearned compassionandcommitmentfrommymom,averydelicatepersonatheart.Ilearned language,reasoning,debating,thinking,determination,outspokennessandselfless servicefrommydadwhoisverytrueatheart,incrediblyarticulateandpowerfulin expression.IalsothankmybrothersRamuandAnil,sister-in-lawLatha,andmylittle nephewGaneshSrinivas,fortakingcareofthingsbackhomewhenIwasaway,without whichthisexpeditiontotheUnitedStateswouldnothavebeenasuccess.Thesepeople arethelocusofmyexistence. Thisdissertationalsoistheculminationofyearsofefforts,directandindirect,of severalteacherswhoeducatedme.Thefirst,andasimportantasmymomanddad,ismy primaryschoolteacher,Lalitha.Shegavemealotofpersonalattentionandsincerely believedthatIwasdestinedtoachievesomethinggreat.Shehaddeepimpactonmy thinkingatthatearlyage.Myprivilegetohoistthenationalflagintheschooleveryyear ontheIndependenceandRepublicdayssowedseedsofcommitmenttoacareerinthe serviceofmynation,anambitionthatIpursuedoverthenext25yearsofmylife.I thankherforherdedicationtotheprofessionofshapingyoungmindsandwishmy countrythegoodfortuneofhavingsuchwonderfulindividualsintheyearstocome. vi   IalsothankmyteachersatPragathiHighSchool,Hyderabad,India—Sarada, Rama,Satya,Shobha,Vidya,Mandakini,Saroja,RajyaLakshmi,Rajeswari,Surya Prabha,tonameafew—whohaveprovidedaverynurturingyetaverychallenging learningenvironmentduringmyadolescentyears.Atthisschool,teachingwasnota business.Itwasapassion.Asenseofcommitmenttostudents’holisticdevelopment pervadeditsenvirons.Thisshapedmyphilosophyoftraining,whicheventuallybecame myprofession.Ispeciallythankmymathematicsteacherandaverygoodfriend,Gopal, becauseofwhoIlatermajoredinMathematics,asubjectthatIwouldotherwisehavenot daredtoventureinto.Whilemathematicsneverhasbeen,norwillbe,asubjectofdeep interesttome,studyingittaughtmeacoreprincipleoflearning—i.e.,nothingisso difficulttolearn,ifonereallywantstolearnit. Myteachers—RajyaLakshmi,Shyamala,NirmalaandLakshmi—from undergraduatecollege,VanithaMahaVidyalaya,haveprovidedveryvaluableguidance whenIwasatcross-roadsintermsoffurthereducationandcareerchoices.They supportedmewhenIwantedtoembarkonunfamiliarroadsandadvisedthatIshould pursuewhatItrulydesired.RajyaLakshmiandShyamalaremainedmypersonal advisorseversince.Isincerelyacknowledgetheircontribution.Dr.Lakshmikanth Reddy,mymarketingteacheratBadrukaCollege,whereIgotmyfirstMBAin1994,is anotherpersonwhodeservesanhonorablemention. Anynumberofthankswillbeinsufficienttoacknowledgeanothergreat gentleman,Dr.S.PratapReddy,Principal-Director,DhruvaCollegeofManagement. Dhruvaisauniqueinstitutionthatprovidesanurturingenvironmentnotonlytoits vii   students,butalsotoitsfacultymembers.Ilearnedthepoweroflisteningtoanopposite point-of-viewwithpatienceanddisagreeingwithrespectfromDr.Reddy(ourTiger).He andhiswife,PushpaLathaReddy,supportedallmyendeavors—whetheritwaspursuing mydreamofjoiningtheIndianAdministrativeServicesorpursuingeducationabroad lateron.Theyweretrulyaphonecallawaytoactonmyrequeststohandlethingsback homewhenIwasintheUntiedStates.IamnotsureifIcaneverrepaytheirkindness.I hadthegoodfortuneofservingthisschoolforadecadeasafacultymemberandamnow extremelyhonoredwithaninvitationtobeonitsgoverningcouncil. ItwasatDhruvathatImetthepersonwhochangedthetrajectoryofmylife—Dr. RaoH.Unnava,ProfessorofMarketingattheFisherCollegeofBusiness,TheOhioState University.Dr.Raoisanincrediblegentleman,averyfineteacher,andatruementor.I thankhimforhisimmensefaithinmyabilitieswhenheadvisedmetojoinaPhD programintheUnitedStateswaybackin1999.Dr.Rao’sentryintomylifeseemsso predetermined.IpickeduponhissuggestiontocomeovertotheU.S.twoyearslater whenIfinallyfailedatgettingmydreamjobandbeingapartoftheadministrative machineryinmycountry.IchosetogetintothePhDprograminStrategyatTheOhio StatealmostfiveyearsafterIfirstmethim.Hewasneverimpatientwithmeabout whichschoolIchosetogotoorwhichsubjectIeventuallywantedtopursuemyPhDin. Dr.Raotaughtme,byexample,averyimportantthingaboutadvising—i.e.,good advisorsgivegoodadviceandalsoleaveenoughlatitudeinimplementation.Heopened anewwindowofthoughtinmymind…itbecamethewindowtotheworld.Hetruly workedinmybestinterestandisamentorforlife. viii   TwootherincrediblementorswhopavedmywaytoDr.JayBarneyattheOhio StateUniversityareDr.GregoryDessandDr.RobertKieschnickduringmymasters’ programattheUniversityofTexasatDallas.Dr.Desshadavisionformeandhasbeen veryveryaffectionate.Hetrulybroughtmebackintoacademia,helpedmemakethe decisiontopursuedoctoralstudiesandencouragedmetogotoanadvisorwhocould contributemosttomyinterests.AshisTA,Igotgoodtraininginacademicwritingand enjoyedgreatflexibilityandindependence.Hecreatedmyfirstcopyrightsandroyalties. Hehasbeen,andcontinuestobe,agreatsourceofencouragementandsupport. Dr.Kieschnick,myfinanceprofessorandmentor,wasalwayswillingtodiscuss, gavetimeandattention,beenaffectionateandshapedmypreliminaryideasthat eventuallyledtochoosingthedissertationtopic.AccordingtoDr.Kieschnick,an assistantprofessor’stenureclockstartsrightatthetimehe/shejoinsthePhDprogram. HethereforethoughtIshouldbeverywell-preparedevenbeforeIgotintoit.BothDr. DessandDr.Kieschnickwantedmetobepreparedforaconversationwithmyadvisor theveryfirstdayImeethim.Thatpreparationhelpedmehit-the-ground-runningwhenI eventuallyjoinedthedoctoralprogramatFisherCollege.Iamdeeplyindebtedthem.I amalsogratefultoJyothiMallick,Director—CohortMBAprogramandProfessors, JosephPicken,ConstantineKonstans,MichaelOlifffortheirvaluablerecommendations, MaryandDavidLawsonandfriends,Charul,Pranav,Arturo,Sherif,Bryan,Daniel(my Cohort),Vinetta,MargieandTaylorDessforkeepinglifegoingwhileatUTD. IalsothankseveralProfessorsattheOhioStateUniversityfortheirsupport throughoutthePhDprogram.MichaelLeiblein,MonaMakhija,JayAnand,Anil ix [...]... important times Padma and her husband Raj have been of great support, both back in India and in the United States Roopa and Glory can be rightfully described as my ‘alter egos’ I truly cherish their friendship and owe them a lot for their faith in my decisions My very close friend and cousin NVK Rao, his wife Raji and their family are inextricably twined in this journey Padma and Srinath, who consider... friend and guide from the corporate world, has been very encouraging, helpful and supportive of my choices Ganesh Sharma, HDPI-HSBC, has also been a valuable source of advice at important junctures xi Added to these friends are Angie, Roger, Taylor, Rose and Jerome (Finance), Hammad and Ayesha (Economics), Vikas, Somnath and Sheenu (Statistics), Jenny and Sandeep (Marketing), Nilesh, Anup, Doug, Alison,... econometric modeling and been very willing to entertain my numerous questions Angie, Anup, Sridhar and Hammad have truly been the econometric and programming backbone for this dissertation My friend Mary (OSU alumnus) and her family, Nilesh, Sujith, Jay Dial, Sandhya, Sridevi (University village) and their families, Gopesh and Sowmya (UIUC), the Bendapudis, the Makhijas, the Unnavas, and my little roomies... deferral options (Folta and O’Brien, 2004; Kulatilaka and Perotti, 1998; Leiblein and Zeidonis, 2007)) or in the context of different investments (eg., pharmaceutical alliances as exploratory investments in real options (Vassolo et al., 2004)), the role of endogenous uncertainty and learning (Sanchez, 1993; Sanchez and Mahoney, 1996) Valuation implications of real options, however, are still a nascent... Karolyi, Werner, Hirshleifer, and others from Finance, Oded Shenkar (International Business), Steffanie Wilk and others from MHR have also been very considerate of my questions and requests Kathy, Heidi and Joan, our administrative support, have been immensely helpful and are the best people I have seen in these roles They truly enjoy their jobs and have been very kind and nice Kathy had to have extraordinary... 9th Avenue —Ashwini, Shikha, Rimky and Vidya—have all been an important part of my social life in Columbus, OH Mary and her family helped with numerous moves, in rain and snow, have been very dependable and kept life under control I cannot imagine how life would have been without Mary in Columbus She has been my ‘one-stop shop solution’ for all questions and problems and is now a friend for life Professors... competitive considerations in options logic (Smit and 6 Ankum, 1993), and interactions among various options (MacMillan and McGrath, 2002; Vassolo, Anand and Folta, 2004)—have also been studied Divestments, on the other hand, are analogous to financial ‘put’ options i.e., the right to sell or divest assets at a future date without an obligation to do so Real options theory has not been applied as extensively... support, trust and camaraderie of several wonderful and very capable friends, who were also my very tough competitors My high school buddies—Ravi, Padma and Raji, my friend from undergrad studies— Roopa and her family, my friends from MBA—Glory, Manohar, Chetan and Senthil, my civil service buddies—Raghunath, Swarna and later Aparna (GMAT), have been with me regardless of success or failure and been my... a firm to delay making a divestment decision and in so doing keep its ‘put’ real options open, and thus that such delays have nothing to do with agency problems 2.2 Theory development and hypotheses 2.2.1 Uncertainty and divestments as ‘put’ options As outlined earlier, business unit divestments can be conceptualized as ‘put’ options on real assets (Myers and Majd, 1990) This is because when the conditions... as it does for investments However, an equally powerful argument for 2 staged divestments comes from the information asymmetry perspective According to this perspective, firms engage in staged divestments to reduce information asymmetry and maximize proceeds from sales (Zingales, 1995) The second essay builds arguments from real options theory and information asymmetry for staged divestments and tests .  AddedtothesefriendsareAngie,Roger,Taylor,Rose and Jerome(Finance), Hammad and Ayesha(Economics),Vikas,Somnath and Sheenu(Statistics),Jenny and Sandeep(Marketing),Nilesh,Anup,Doug,Alison,Ty and Asli(Strategy),Janice,Chad, Marie and Aden(MHR)attheOhioState.Theyentertainednumerousquestions and have beenpatientwithmethroughoutthePhDprogram.Susan,Charlie,Joe,Erin,Suresh, Sungho,Song,Yuping and Chrisarevaluableadditions.Sridhar(SASconsultant)has beenextremelygenerousininvestingtime and effortfortrainingmeinSAS and continuestoextendhisprofessionalexpertisetomyprojects.Hammadhasbeen extremelyhelpfulwitheconometricmodeling and beenverywillingtoentertainmy numerousquestions.Angie,Anup,Sridhar and Hammadhavetrulybeenthe econometric and programmingbackboneforthisdissertation. MyfriendMary(OSUalumnus) and herfamily,Nilesh,Sujith,JayDial, Sandhya,Sridevi(Universityvillage) and theirfamilies,Gopesh and Sowmya(UIUC), theBendapudis,theMakhijas,theUnnavas, and mylittleroomiesat251West9 th  Avenue—Ashwini,Shikha,Rimky and Vidya—haveallbeenanimportantpartofmy sociallifeinColumbus,OH.Mary and herfamilyhelpedwithnumerousmoves,inrain and snow,havebeenverydependable and keptlifeundercontrol.Icannotimagine how lifewouldhavebeenwithoutMaryinColumbus.Shehasbeenmy‘one-stopshop solution’forallquestions and problems and isnowafriendforlife.ProfessorsTom Lumpkin(TexasTech),JayJanney(UniversityofDayton),AlanEisner(Pace),Marilyn Taylor(UMKC),SaikatChowdhury(Wharton),NandiniLahiri(UNC),Seung-HyunLee (UTDallas) and mycolleaguesfromotheruniversitiesManishaSingal(VirginiaTech), xii .   WHY AND HOW DO FIRMS DIVEST?           DISSERTATION   PresentedinPartialFulfillmentoftheRequirementsfor theDegreeDoctorofPhilosophyintheGraduate SchoolofTheOhioStateUniversity  By  NagaLakshmiDamaraju B.Sc.M.B.A.P.G.D.E.M.L.L.B.M.B.A.M.S.  *****   TheOhioStateUniversity 2008   DissertationCommittee:  ProfessorJayB.Barney,Adviser.  Ray(Entrepreneurshipcenter),Mr.Popovich(Librarian),AmyRichards and Naveen Baddam(Advising)havealsobeenverykindonseveraloccasions.IalsothankCouncil forGraduateEducationinBusinessAdministration and HayesForumfortravelfunding. Throughoutthisjourney,Ienjoyedincrediblesupport,trust and camaraderieof severalwonderful and verycapablefriends,whowerealsomyverytoughcompetitors. Myhighschoolbuddies—Ravi,Padma and Raji,myfriendfromundergradstudies— Roopa and herfamily,myfriendsfromMBA—Glory,Manohar,Chetan and Senthil,my civilservicebuddies—Raghunath,Swarna and laterAparna(GMAT),havebeenwithme regardlessofsuccessorfailure and beenmysponsorsatseveralimportanttimes.Padma and herhusbandRajhavebeenofgreatsupport,bothbackinIndia and intheUnited States.Roopa and Glorycanberightfullydescribedasmy‘alteregos’.Itrulycherish theirfriendship and owethemalotfortheirfaithinmydecisions.Myveryclosefriend and cousinNVKRao,hiswifeRaji and theirfamilyareinextricablytwinedinthis journey.Padma and Srinath,whoconsidermetheirdaughter,areaveryimportantpartof thesupportnetwork.Allthesepeopleknowmyaspirations and boostedmycouragewhen itwashittingrockbottom.Icannotthankthemenough.MycolleaguesatDhruva College,Venu,Loknath,Aparna,Sailaja,Usha,Chakri,Suresh,Dashrath,Gopal and Veerahavetakencareofseveralissuesbackhomewhenneeded and trulydeservetobe mentioned.MystudentsatBadruka and Dhruvahavebeensourcesoffreshideas and enthusiasmalways.Ramanathan,NIS-Sparta,myfriend and guidefromthecorporate world,hasbeenveryencouraging,helpful and supportiveofmychoices.GaneshSharma, HDPI-HSBC,hasalsobeenavaluablesourceofadviceatimportantjunctures. xi 