Financial Distress, Asset Sales, and Lender Monitoring

Author(s): M. Ameziane Lasfer, Puliyur S. Sudarsanam and Richard J. Taffler

Source: Financial Management, Vol. 25, No. 3, Special Issue: European Corporate Finance
(Autumn, 1996), pp. 57-66
Published by: Wiley on behalf of the Financial Management Association International
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Financial

Lender

Distress, Asset
Monitoring

Sales,

and

M.Ameziane Lasfer,PuliyurS. Sudarsanam,and RichardJ. Taffler

M. Ameziane Lasfer is Lecturer in
Finance, Puliyur S. Sudarsanam is
Professor of Finance and Accounting,
and Richard J. Taffleris Professor of
Accounting and Finance at the City
University Business School, London.

This paper examines the differing reactions of the stock market to

divestmentsby financiallydistressedandhealthyfirms,andthe impactof
lendermonitoringon thatreaction.Fora sampleof UK divestorswe find
excess returnsat the time of sell-off announcementsare positive and
statisticallysignificant,butarefarhigherfor financiallydistressedfirms.
Thesehigherreturnsappearto be an adjustmentfor reductionin financial
distresscosts. Consistentwith efficient lendermonitoring,significantly
higherreturnsareassociatedwith higherlevels of debt,especiallyin the
case of distressedfirms.The paperconcludesthat,in the UK at least, the
main benefit from divestiturescomes from the resolutionof financial
distress.

MA number of factors that motivate company

management to undertake divestments affect share
price. In many cases, divestments are undertaken by
companies as a means of transforming their business
portfolio. In others, they are designed to steer the
company out of potential bankruptcy (Ofek, 1993).
Stock marketreaction to the divestment announcement
and the consequent change in shareholder wealth
reflect the motive behind the divestment decision.
This study compares the stock price reaction to
divestment decisions announced by both financially
distressed and financially healthy firms. By focusing
explicitly on bankruptcyrisk, it extends previous work
on stock market reaction to voluntary sell-offs.
In particular, we explore whether divestments by
distressed firms are a means for regaining financial
strength. We examine whether such activity leads to
shareholder wealth enhancement through the
avoidance of direct and indirect costs associated with
potential bankruptcy. We also look at the impact of
lender monitoringon stock marketreaction. Finally we
control for other characteristics of the divestment
announcement, viz. relative size of the assets divested
and the stage of completion of the deal.
Our results indicate that there are statistically and
economically significant positive abnormalreturnsto
shareholders of financially distressed firms. These
returnscontrast with the very low (albeit still positive
and significant) returns experienced by shareholders

of financially healthy firms. This result is consistent

with the notion that distressed-firm shareholders
benefit from the reduction in distress costs brought
aboutby divestments. Also, we find divestor debt level
has a positive and significant impact on shareholder
returns,especially in the case of distressed firms. This
finding is consistent with the argument that efficient
monitoring by lenders leads to value-enhancing
corporate decisions.
The relative size of the divestment has a positive
and significant impact on the returns to healthy-firm
shareholders but has no impact for distressed-firm
shareholders. On the other hand, the increased degree
of certainty associated with a completion
announcement, as opposed to the mere statement of
intention to divest, has no significant impact for either
set of shareholders.
We explore the theoretical issues in Section I. We
describe the sample, data, and methodology in Section
II. We present and discuss our empirical results in
Section III, and provide our conclusions in Section IV.

I. Theoretical Background
Empirical evidence demonstrates that, on average,
divestitures lead to significant share price increases.
Table 1 summarizes this evidence. There are two
principal theories that seek to explain such value
increase by 1) improving "fit and/or focus" (John and

Financial Management, Vol. 25, No. 3, Autumn 1996, pages 57-66

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58

FINANCIAL
/ AUTUMN
MANAGEMENT
1996

Table 1. SummaryResults of VoluntarySell-OffStudies

MAR = mean adjusted returns model; MM = market model; MKADJ = market-adjusted returns model; N/A= not
available. Event days are relative to t = 0, the announcementday.CARsarethosereportedin theoriginalstudies.Announcement
datesof divestmentintentionandcompletionareindicatedby - and+, respectively.

Study, Year

Sample Size
and Period

Methodology

CAR(%)

Event Days

Test Statistic

Hearth & Zaima, 1984

MM

3.55

(-5,5)

t = 3.14"**

58
(1979-81)

Rosenfeld, 1984

MAR

2.33

(-1,0)

t = 4.60***

62
(1969-81)

Alexanderet al., 1984

MKADJ

0.40
-0.31

(-1,0)

NS
NS

Linn & Rozeff, 1984

N/A

1.45

(-1,0)

t = 5.36***

53
39
(1964-73)
77
(1977-82)

Montgomeryet al., 1984

Jain, 1985

MM

MM

7.25

0.09

(-12 months, 12
months)

NS

(0)

NS

78
(1976-78)
1064
(1970-78)

Klein, 1986

MM

1.12

(-2,0)

t = 2.83***

202
(1970-79)

Hearth& Zaima, 1986

MAR

1.42

(-1,0)

t = 4.06***

75
(1975-82)

Hite et al., 1987

MM

1.66

(-1,0)

z = 4.08***

55
(1963-83)

Hirschey & Zaima, 1989

MM

1.64
2.83

(-1,0)

t = 4.02***
t = 5.12***

64
26
(1975-82)

Hite & Vetsuypens, 1989

MM

1.12

(-1,0)

z = 9.12***

468
(1973-85)

Hirschey et al., 1990

Denning & Shastri, 1990

MAR

1.47

(-1,0)

t = 4.36***

MKADJ

-0.01
0.01

(-6,6)
(T-6,T+6)?

NS
NS

75
(1975-82)
50
(1970-81)

Sicherman & Pettway, 1992

MM

0.92

(-1,0)

z = 6.33***

278
(1981-87)

Afshar et al., 1992

MM

0.85

(-1)

t = 5.23***

178
(1985-86)

Brown et al., 1994

MM

0.10

(-1,0)

NS

62
(1979-88)

John & Ofek, 1995

MM

1.50

(-2,0)

***

321
(1986-88)

Lang et al., 1995

MM

1.41

(-1,0)

z = 3.61***

93
(1984-89)

***Significant at the 0.01 level, NS denotes not significant at the 0.05 level.

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LASFER,SUDARSANAM,&TAFFLER/ FINANCIALDISTRESS,ASSETS SALES & LENDERMONITORING

Ofek, 1995) and 2) reducing the costs of financial

distress.
However, these two theories are not mutually
exclusive. Lenders can gain at the expense of
shareholders if sell-off proceeds are used to pay down
debt. However, the empirical evidence on the impact
of paying down debt on shariholder wealth gains from
sell-offs is inconclusive (Brown et al., 1994; Lang et
al., 1995). For the purposes of this paper, we assume
that if bankruptcyand its associated costs are avoided,
both stakeholdersbenefit. This paperfocuses explicitly
on the comparative wealth experience of shareholders
in financially distressed and financially healthy firms
that conduct voluntary sell-offs.

59

wealth increments should equal the net present value

(NPV) of the divestment. However, with financially
distressedfirms, the wealthincrementsexceed the NPV,
since the probabilityof eventual liquidation is lowered
and the expected liquidation costs are reduced
(Burgstahler et al., 1989). Thus, we expect higher
returns for distressed-firm shareholders than for
healthy-firm shareholders.' To allow us to focus
explicitly on divestorswho experiencefinancialdistress
prior to sell-offs, we employ a widely used measure of
bankruptcy risk, the z-score (Altman, 1968; Taffler,
1984).
The arguments stated above are tested against the
following null hypotheses:

A. Divestment by FinanciallyHealthyFirms

Sell-offs by potentially bankruptfirms do not

1Ho-: generate significant abnormalreturns when
John and Ofek (1995) examine fit and focus as the
divestments are announced.
two primary motivations for asset sales. Where the
divested asset has a better fit for the buyer than for
HI: There is no significant difference in market
the divestor, value can be created by the sell-off and
reaction between divestments by financially
the two firms can "split the difference"(Sichermanand
healthy and financially distressed firms.
Pettway, 1992). Where a business goes "out of focus"
and begins creating negative synergy, selling it off
Following our earlier analysis, we expect abnormal
can lead to enhanced performance of the divestor's
returnsto sell-off by financially distressed firms to be
remaining portfolio and a consequent shareholder
and higher than those of financially healthy
wealth increase. John and Ofek (1995) reportevidence positive
firms.2
supporting of both motivations.

B. Divestments by FinanciallyDistressed
Firms

D. Impactof LenderMonitoring

Debt has an agency monitoring role (Jensen, 1989).

We would thereforeexpect thatthe higher the leverage,
One way to deal with financial distress is to generate
the more likely it is that divestments will be
sufficient cash through asset sales to meet debt
value-enhancing.Further,if debt has a significant bank
obligations (John, 1993). Several studies provide
lending component, its monitoring role is reinforced.
empirical evidence that supports this argument (e.g.
et al. (1990) argue that the presence of bank
Ofek, 1993; Asquith et al., 1991; Brown et al., 1994). Hirschey
debt adds credibility to management's divestment
Such divestments allow a firm to avoid both direct and
decision by increasing the probability that net
indirect financial distress costs. Direct costs cover,
will exceed the NPV of continued ownership
inter alia, legal and administrative expenses (Gilson proceeds
of the divested asset by the divestor. Significant bank
et al., 1990; Weiss, 1990; Betker, 1995). Indirect
debt should thus be associated with higher returns to
bankruptcy costs, which are likely to be more sell-offs.
Hirschey et al. find that the level of bank
substantial than direct costs, include the opportunity
debt has the anticipated positive relationship with
cost of suboptimal operating and investment decisions
shareholderreturns.We posit such monitoring is even
(Altman, 1984; Gilson et al., 1990). Stakeholderssuch
as customers, suppliers, lenders, and employees may 'Hearth and Zaima
(1984) and Sicherman and Pettway (1992)
be reluctantto transactwith a firm in financial distress
investigate the relative abnormal returns to "good" and "poor"
(Cornell and Shapiro, 1987). See Chen, Weston and financial status divestors and report significantly higher returns
Altman (1995) for a recent synthesis of the theoretical to good-firm shareholders. They attribute this to greater
literature on financial distress. There are, therefore, negotiating power vis-a-vis the buyers. However, their financial
status measures do not relate to bankruptcy potential.
substantiala priori groundsfor expecting a shareholder 2Any positive NPV from an asset sale a
by financially distressed
wealth gain if bankruptcyis avoided and the financially firm may be appropriated by lenders. If so, shareholders may
distressed firm recovers its financial health.
experience smaller gains from the sale than when the proceeds

C. ComparativeImpactof Divestments by
Distressed and HealthyFirms
In the case of a healthy-firm divestor, shareholder

are not used to pay down debt (Brown et al., 1994). While we
do not examine how the divestment proceeds are used by our
sample firms, the presumption that they are used to pay off
lenders introduces a bias against observing significant positive
abnormal returns for our distressed sample.

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60

FINANCIALMANAGEMENT
/ AUTUMN1996

more benign when the divestor is financially distressed

and the bankruptcy event is avoided.3 The following
null hypothesis is tested:

equity market capitalization of the financially

distressed sample is ?52m, ranging between ?3m to
?530m. For the healthy firms, the mean marketvalue is
?679m with a range of ?2m to ?6,717m. This latter
sample has 15%of marketvalue above ?lbn. The mean
HI3:The comparative stock market reactions to
divestments by financially healthy or financially divestment size for the distressed firms is ?3.2m with a
distressed firms do not differ with debt level.
range of ?45,000 to ?21.2m. For the healthy firms, the
equivalent figures have a mean of ?17.8m, and range
E. Impactof ControlVariables
between ?62,000 and ?686m.
The sample includes 28 firms identifiedas potentially
Earlier studies show a positive relationship between
a
used UK-based z-score
relative size of divestment and shareholder wealth bankruptby applying widely
model (Taffler,1984) akinto Altman(1968). Firmswith
increase(e.g. Klein, 1986;Afsharet al., 1992). Similarly,
a negative z-score are classified as potential failures,
if the divestor announces completion of the deal (as
as their financial profiles resemble those of previously
opposed to mere intention to divest) market reaction
firms.
is more positive (e.g. Hearth and Zaima, 1986; Klein, bankrupt
The model, developed using linear discriminant
1986; Afshar et al., 1992). In both cases, we would
techniques, takes the following form:
expect stock market response to be greater for
financially distressed firms.
z = c+ cIx,+ c2X2c3X3+c4X4
(1)

II.Sample and EmpiricalMethodology

A. Sample
Initially, we examine all firms that announced
divestments inAcquisitions Monthlybetween January
1985 and December 1986.4 From this population we
select nonfinancial firms with sell-off announcements
only. Following Bi and Levy (1993), our initial
observation period runs from ten days prior to
divestment announcement (t=0) to ten days postevent. To avoid confounding measurement of market
reaction to the divestments (Denning and Shastri,
1990), we exclude firms with overlapping
announcements of other important events, such as
bids or disposals that occur within the 81-day window
centered on day t=0.
Our final sample consists of 142 UK manufacturing,
construction, and retail companies that sold off part
of their assets duringthe period 1985-86.5 The average
3Gilson et al. (1990) provide further evidence of banks'
superior monitoring abilities in financially distressed firms in
the context of private debt restructuring.
4Acquisitions Monthly records, inter alia, details of all
corporate divestments that are announced to the London Stock
Exchange (LSE) by UK firms listed on the LSE, mentioned in
company press releases, or reported in the financial press. In
most cases, the announcement date is the date of release of
information by the divesting firm. In a few cases, however,
the dates provided are those of the relevant press reports,
taken as the first public indication of the sell-off event. Note
that stock market access to such information may have predated press publication. Where possible, dates were also crosschecked with Financial Times Mergers and Acquisitions
International.
5 Event dates are not clustered in calendar time. The
observations are distributed quite evenly across the sample

where x ...x4 denote the financial ratios, and Co...c4the

coefficients which are proprietary. There are two
versions. The first is used to analyze listed
manufacturing and construction companies and has
component ratios (with Mosteller-Wallace percentage
contribution measures in brackets): profit before tax/
currentliabilities (53%), currentassets/total liabilities
(13%), current liabilities/total assets (18%), and nocredit interval (16%). The second variant is used to
rate listed retail enterprises and has ratios: cash flow/
total liabilities (34%), debt/quickassets (10%), current
liabilities/total assets (44%), and no-credit interval
(12%).
Taffler (1995) tracks the performance of this model
from its development. Overall, it has had a better than
98% success rate in classifying subsequently bankrupt
companies as potentially insolvent (z<0) based on their
last accounts prior to failure, and exhibits true ex ante
predictive ability in statistical terms.

period with 44% of the divestments occurring in 1985 and the

remainder in 1986. The following table shows the monthly
distribution of divestment announcements in percentages:
Month

85
86
I

10
5
7

12
9
10

9
9
9

4
2
3

1
0
0

3
4
3

Month

85
86
1

16
7
11

9
9
9

10
7
8

9
16
13

9
10
10

where I is the combined total.

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8
22
16

LASFER,SUDARSANAM,&TAFFLER/ FINANCIALDISTRESS,ASSETS SALES & LENDERMONITORING

61

where CARTis the cumulative abnormalreturnover T

days and oAR is the standard deviation of the daily
Daily returninformationand pre-observationperiod average abnormalreturns.
equity market capitalization data were drawn from
If the abnormalreturnsare normal, independent,and
DatastreamInternational,an on-line financial database.
identically distributed, the test statistic is a Student t
The debt financing ratio is taken from the under the null
hypothesis. Given that the event dates
MicroEXSTAT computerized financial statement are not
clustered, we do not expect that ignoring any
database provided by Extel Financial. This ratio is
possible cross-sectional dependence will induce
defined as book value of total debt/book value of total
significant bias in the variance estimates (Brown and
capital employed (net capital employed plus short-term Warner,1985). In line with the researchshown in Table
debt).6
1, we focus on event window days (-1,0) to allow for
ambiguity in the timing of release of divestment
C. Methodology
announcements.
We test H02using the t-statistic for the difference in
Our empirical methodology is designed to measure
cumulative
average abnormal returns between the
the impact of divestment announcements and the
distressed
sample, CARD, and that for the
relationship between stock market reaction and financially
healthy sample, CARH,
bankruptcyrisk and lender monitoring.
CARD-CARH
1. Estimationof AbnormalReturns

B. Data

td=

We use the conventional mean-adjusted returns

(MAR) model (Brown and Warner,1985; Bi and Levy,
1993) to test H01,and H02. We compare daily returns
duringthe observationperiod to the mean daily returns
of the pre-announcementestimation period (t= -200
to t=- 11).Abnormal returns associated with the selloff event are represented by the excess of actual over
the mean benchmarkreturns.The cumulative portfolio
abnormal returns for any interval in the observation
period are the average abnormalreturnssummed over
that interval. The MAR model minimizes the bias in
the expected returnsthat arises with the marketmodel
because of the small size effect (e.g., Levis, 1989;
Dimson and Marsh, 1986) and the bias introduced in
the share price behavior of financially distressed firms
(e.g., Aharony et al., 1980; Theobald and Thomas,
1982).7
We test Ho0by using the following test statistic
based on the ratio of the MAR to the estimated
standard deviation of the daily average abnormal
returns during the estimation period (Brown and
Warner,1985, Equation5):
t=

CAR
T 1/2AR
AR

(2)

6Due to the absence of a well-developed corporate bond market,

debt financing in the UK is provided primarily by the
commercial banking sector. Even short-term bank debt
functions as a permanent source of loan capital. Further, our
choice of book, rather than market, value of equity reflects
the predominant use of the former measure in bank loan
covenants.
7To explore the sensitivity of our results to potential
benchmark error, we also replicate our abnormal returns
analysis using the market-adjusted model (b=l) (Brown and
Warner, 1985). These results are not reported here as the
conclusions are similar, but are available from Lasfer on request.

T1/2

T/2

((2ARD

2AR,D

A2

(31/2)

2AR,H12

where 0AR,D and aAR,Hare the standard deviations of

the daily average abnormalreturns for the financially
distressed and the healthy samples, respectively, and
T is the cumulation interval in days. This test is
appropriateunder the assumption that we are dealing
with independent random samples with different
variances (see Sicherman and Pettway, 1987, footnote
4, for details of this test).

2. Estimationof Impactof LenderMonitoring

To test H03, the following model regresses two-day
(-1,0) abnormalreturnson the debt financing ratio, the
relative size of divestment, and a dummy variable for
sell-off completion announcementversus an intentiononly announcement.We also include in the regression
interactive terms to measure the joint impact of these
variables and divestor financial status. We estimate
the following equation:
= a + P1Di + f'1D
AR(1,o0)i
DiZi+ 2Si+
S

Ei

2SiZ + P3Ci

(4)

C'3iZi"C7
AR(-,Oiis the abnormalreturnfor firm i on days -1 and
0 where
D.

is the pre-divestment debt financing ratio

derived from the firm's last published
accounts prior to the divestment event.

Z.

is the measure of financial status equal to 1

for financially healthy (i.e. positive z-score)
and 0 for financially distressed (i.e. negative
z-score) firms.

Si

is the relative divestment size represented by

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62

FINANCIALMANAGEMENT
/ AUTUMN1996

Figure 1. Cumulative Abnormal Returns for 21-day Event Period Centered on Announcement
Day 0 for the Financially Distressed and Financially Healthy Samples
0.06
C,

ci
a)

0.04

CO

-0

0
E -0.02
0.04
-15

-10

-5

10

15

Days Relative to Divestment Date

i FinanciallyDistressed

FinanciallyHealthy

drift for both samples prior to the divestment event is

the ratio of sell-off size to firm i's equity
market value as at the end of the calendar
clearly reversed by the announcement.
Table 2 summarizes the CARs for selected
month immediately priorto the announcement
observation
windows for the full sample, and
day.
for
the two healthy and distressed
separately
The
is
a
variable
the
value
of
if
one
C1
subsamples.
two-day (-1,0) CAR for the full sample
dummy
taking
is
which
is
is
announced
and
zero
for
0.82%,
significantat the 0.01 level and similar
completion
in magnitude to the returns reported in earlier studies
intention only.
(see Table 1). For the same window, the financially
C
is the errorterm with zero mean and constant distressed firm sample CAR is 2.12%, which is
variance.
significant at the 0.01 level. The CAR for the financially
healthy firms is 0.49%, which is significant at the 0.05
level. We therefore reject
Ill. EmpiricalResults
H01.
The difference in two-day event period CARs of
In this section we present the results of the tests of 1.63% between the two
samples is statistically
our null hypotheses.
at
the
0.05
level.9
Whereas the impact of
significant

A. Abnormal Returns Around the Divestment

Event
Figure 1 charts the cumulative average abnormal
returns (CARs) for the 21-day event period centered
on the announcement date.8 The apparent downward
8 Five individual extreme outliers in the financially distressed
sample defined as AR > 15%, for days -5, -6, +9 (2 cases) and

+10, were replaced by mean values to minimize their distorting

impact on the results, given the small sample size. However,
no such adjustment was required for any of the other days in
the 21-day observation period, particularly days -1 and 0.
9 The results using the market-adjusted model benchmark are
similar. For the financially distressed firms, the 2-day (-1,0)
CAR is 1.82% (t=2.33). For the financially healthy sample it
is 0.45% (t=1.71). The difference of 1.37% is significant at
the 0.10 level (t=1.71).

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MONITORING
ASSETSSALES&LENDER
&TAFFLER
/ FINANCIAL
DISTRESS,
LASFER,SUDARSANAM,

63

Table2. Distributionof CumulativeAverage AbnormalReturns(CARs)(%)of All Firms(142

firms), FinanciallyDistressed Sample (28 firms), and FinanciallyHealthySample (114 firms)
over Selected Observation periods
Abnormalreturnsarethe differencebetweenthe actualreturnsandthe meanreturnsderivedfromthe estimationperiod.
The statisticsarederivedaccordingto Equations2 and3.
Distressed

All Firms

Healthy

Cumulation
Interval
(T days)

CAR %

-10 to 10

-0.10

CAR %

CAR %

-0.13

2.22

0.95

-0.42

-0.52

1.13

-2 to 0

1.27

4.25***

1.70

1.94*

1.16

3.81***

0.58

-1

0.24

1.38

0.91

1.80*

0.07

0.42

1.57

0.58

3.34***

1.21

2.38**

0.42

2.39**

1.47

-1 to 0

0.82

3.34***

2.12

2.96***

0.49

1.99**

2.21

1 to 10

0.32

0.59

0.35

0.22

0.32

0.57

0.02

***Significant at the 0.01 level.

**Significant at the 0.05 level.
*Significant at the 0.10 level.

Table3. ExplanatoryDescriptive Statistics

The debt Financing Ratio is total debt/book value of total capital employed, including short-termdebt. Relative Divestment
Size is the ratio of the sell-off to divestor's equity capitalization at the end of the calendar month prior to the announcement
day. Completion Announcement is a dummy variable equal to 1 if the divestment announcement states completion of selloff, 0 if only the intention to sell-off is announced. The test statistic td is for the difference in means between healthy and
distressed samples. In the case of the completion variable, it is based on the test for difference in sample proportions.
All Firms
Variable

Distressed Firms

Healthy Firms

Mean

Median

St. Dev.

Mean

Median

St. Dev.

Mean

Median

St. Dev.

Debt Financing
Ratio

0.33

0.32

0.15

0.49

0.48

0.15

0.29

0.30

0.12

6.39***

Relative
Divestment
Size (%)

8.8

4.2

7.7

4.0

9.8

1.74*

Completion
Completion
Announcement

0.56

11.2

13.4

0.50

5.0

15.0

0.58

td

-0.76

***Significant at the 0.01 level.

*Significant at the 0.10 level.

the divestment event is small in the case of the

financially healthy firms, in contrastit is economically
material for the distressed firms. This is consistent
with sell-offs representing a mechanism for restoring
financial health. We must, therefore, also reject H02'10
Neither period (days t = -10 to -2) nor period (days
10 If the event window

is extended to (-2,0),

Hol is still

t = +1 to +10) generate statistically significant

differences between the financially distressed and
financially healthy samples. Our results differ from
supported, with the distressed firm sample experiencing a CAR
of 1.70%. However, although this CAR still exceeds that for
the healthy firms by 0.54%, this difference, as Table 2 shows,
is no longer significant. A broadly similar conclusion applies
when event days -1 and 0 are considered separately.

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64

FINANCIALMANAGEMENT
/ AUTUMN1996

Table4. Regression Analysis of Two-Day(-1,0) AbnormalReturnon ExplanatoryVariables

(Equation4)
Coefficients

(t statistic)
Adj. R2

Pa
-0.026**
(-2.46)

0.118***

-0.057*

(3.82)

(-1.82)

-0.039
(-1.10)

p12

0.109***
(3.86)

(F- Statistic)

,3
-0.008

0.012

0.25

(-0.51)

(0.66)

(7.06)

***Significant at the 0.01 level.

**Significant at the 0.05 level.
*Significant at the 0.10 level.

those of Hearth and Zaima (1984) and Sicherman and

Pettway (1992), inter alia, reflecting our study's clear
focus on financial distress. They emphasize the need
to account explicitly for the financial condition of the
divestor when evaluating market reaction to the selloff event.

B. Impactof ExplanatoryVariables
Table 3 reports descriptive statistics for the
explanatory variables in Equation (2). As we would
expect, the distressed firms rely to a much greater
extent on debt financing, with their mean debt
financing ratio almost 70% higher. This difference is
significant at the 0.01 level. Sell-offs by these firms are
also of greater relative size, on average, than those of
the healthy firms, with the difference significant at the
0.10 level. On the other hand, the two samples do not
differ in terms of the relative frequency of completion
versus intention-only announcements.
Table 4 presents the coefficient estimates for the
regressionmodel Equation(4). The results indicate that
a significant proportion of the market reaction to selloffs is explainedby the explanatoryvariables(R2=0.25).
The coefficient on the debt financing ratio D, is
positive and significant at the 0.01 level. This suggests
that debt obligations lead to effective monitoring of
managers, compelling them to take value-maximizing
decisions. This is consistent with the arguments of
Jensen (1989) and Ofek (1993). Further,the negative
(and significant at the 0.10 level) coefficient on the
indicates that such monitoring is
interactive term
DAZi
more effective in the case of the distressed firms, as
argued above. This result also highlights the
incremental impact of bankruptcy risk on divestor
returns over and above that of debt level and points
to the danger of using debt level as a proxy for
bankruptcyrisk. H03is therefore rejected.
The announcement of divestment completion (as

opposed to just the intention to divest) has no

significant impact on shareholder returns for either
the distressed or healthy samples. The relative size of
the divestment has a significant and positive impact
on abnormalreturns only for the healthy group. This
is indicated by the positively signed and highly
significant (at the 0.01 level) coefficient on the
interaction term
but a non-significant coefficient
SZi,
for Si alone.

IV.Discussion and Conclusion

Our study adds to the emerging literature on how
companies resolve financial distress. In particular,we
explore the use of asset sales as a strategy by
potentially bankruptfirms to amelioratetheir financial
situation. Market reaction to divestments undertaken
by financially distressed firms is contrasted with that
for financially healthy companies. Overall, consistent
with the generality of earlier studies, voluntary selloff appears to be a shareholder wealth enhancing
decision. However, in the UK, such wealth
enhancement is predominantly driven by divestitures
of financially distressed firms, while abnormalreturns
to healthy firms are not economically significant. The
higher returnsto financially distressed firms therefore
appear to be an adjustment for reduction in financial
distress costs.
Our cross-sectional regression results also show
that market reaction to sell-off announcements is
positive and contingent upon lender monitoring as
proxied by the level of debt. Such monitoring is even
more beneficial in the case of financially distressed
firms, providing strong support for Jensen's (1989)
argument that lenders play an important role in
reducing agency costs.
The added certainty of completion, ratherthan mere
stated intention to divest, has no significant impact
on shareholder returns following divestment. By

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LASFER,SUDARSANAM,&TAFFLER/ FINANCIALDISTRESS,ASSETS SALES & LENDERMONITORING

contrast, the relative size of the divestment is

significant for the healthy, but not for the distressed,
firms in influencing marketreaction. These results are
largely contrary to our prior expectations. They may
be driven by other mediating variables not included in
the regression, such as the predivestmentperformance
of the sold-off businesses.
In addition to divesting assets, several options, such

65

as financial restructuring, refinancing, management

changes, and mergers, are available to potentially
bankrupt firms. Our results suggest that sell-off is
regarded by the stock market as a viable "escape
route."
The basic conclusion of this paper is that, in the UK
at least, the main benefit from divestitures comes from
the resolution of financial distress. 0

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