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The Financial Review 41 (2006) 361--386
Corporate Governance and Asset Sales:

The Effect of Internal and External
Control Mechanisms
Robert C. Hanson∗
Eastern Michigan University
Moon H. Song
San Diego State University
Abstract
We investigate firms that sell assets to determine whether corporate governance mecha-
nisms are effective at controlling agency problems. Our evidence shows that these firms have
lower managerial ownership and are more likely to make unrelated acquisitions, suggesting
weak internal controls. Analysis of insider trading activity shows that, on average, net buying
increases before the asset sale and shareholders benefit more when this occurs. Results suggest
that how managers reach a given level of ownership provides more information about incentive
alignment than just the level of ownership. Our results also highlight the dynamic nature of
corporate restructuring as firms acquire and then sell assets.
Keywords: asset sales, divestitures, managerial ownership, board structure, insider trading
JEL Classifications: G32, G34
∗ Corresponding author: Department of Accounting and Finance, College of Business, Eastern

Michigan University, Ypsilanti, MI 48197. Phone (734) 487-9747; Fax (734) 482-0806; E-mail:
robert.hanson@emich.edu
We thank Cynthia Campbell (editor) and anonymous reviewers for helpful comments. Robert Hanson
acknowledges financial support from an Eastern Michigan University Spring-Summer Award for Research
and Creative Activity.

c 2006, The Eastern Finance Association 361
362 R. C. Hanson and M. H. Song/The Financial Review 41 (2006) 361–386
1. Introduction
Empirical studies of divestitures show that shareholders benefit from asset sales.
These gains are usually attributable to moving resources to higher-valued uses. More
recent studies suggest that shareholders gain because the asset sale reduces value-
destroying diversification and increases focus.1 Although diversification or lack of
focus may be the symptom that asset sales are intended to cure, the root problem
could be poor internal control mechanisms that allow managers to pursue their own
objectives. In this article, we investigate whether the gains from asset sales reflect
the lessening of agency conflicts that lead to diversification or other forms of over-
investment. We investigate the ownership structure, board structure, insider trading
activity, and takeover activities of firms that sell assets, and relate these measures of
internal and external controls to the shareholder gains from asset sales.
The benefits associated with divesting assets are well documented, recently by
Mulherin and Boone (2000), who suggest that firms efficiently respond to changing
economic conditions. Where these gains come from is less well known, but sev-
eral studies suggest that asset sales correct overinvestment. Hite, Owers, and Rogers
(1987) suggest that asset sales remove negative synergies and move assets to higher
valued uses. Asset sales can reverse overinvestment by selling unrelated assets and
making the firm more focused (John and Ofek, 1995), by correcting inefficient in-
vestment (Dittmar and Shivdasani, 2003), or by undoing failed acquisitions (Kaplan
and Weisbach, 1992). Managers overinvest when they pursue diversification as a way
to reduce their own human-capital risk (Amihud and Lev, 1981; May, 1995), pur-
sue a corporate wealth strategy (Donaldson, 1984), invest in manager-specific assets
(Shleifer and Vishny, 1989), follow a growth strategy to maximize firm size (Lang,
Poulsen, and Stulz, 1995), or to increase compensation related to firm size (Baker,
Jensen, and Murphy, 1988). Strong internal control mechanisms, however, should
reduce the likelihood that overinvestment becomes a severe problem, help correct the
problem when the costs become too high, or persuade managers to sell assets that they
are reluctant to sell (Boot, 1992). When internal control mechanisms are ineffective,
shareholders must rely on external mechanisms such as active investors to monitor
managers or the threat of takeover to constrain wasteful managerial decisions (Jensen,
1991, 1993).
Other recent studies that examine the effectiveness of internal controls include
Denis and Denis (1995) who examine firm performance after management dismissals,
Kang and Shivdasani (1997) who examine corporate restructuring by Japanese firms,
and Denis and Kruse (2000) who examine disciplinary events that reduce incumbent
managers’ control. Each of these studies finds evidence that internal control mech-
anisms have a significant effect on disciplining managers or initiating restructuring
activities. Our study differs from these studies on several accounts. Because poor
1 See Alexander, Benson, and Kampmeyer (1984), Rosenfeld (1984), Jain (1985), Hite, Owers, and Rogers
(1987), and John and Ofek (1995).
R. C. Hanson and M. H. Song/The Financial Review 41 (2006) 361–386 363
performance is not a pre-requisite for assets sales, and to better understand why firms
sell assets, we examine an unconditional sample of firms that sell assets. Our sample
encompasses a longer period, 1981–1995. Finally, we take a fresh look at the impact
of managerial ownership and add a dynamic component to this metric by analyzing
insider trading activity to show how managers adjust their stock holdings before the
divestiture.2
We compare the internal and external control mechanisms of a sample of 263
firms that sell assets with a matched control sample of nondivesting firms. Asset
sales provide an interesting setting in which to examine corporate governance issues
because they involve decisions that typically are purely discretionary on the part of
management. Weak internal controls, for example, could allow managers to use the
sale to further their own objectives (Lang, Poulsen, and Stulz, 1995). Strong internal
controls, however, could motivate reluctant managers to sell assets (Boot, 1992) or
bargain away some of the value that the buyer expects to create (Hanson and Song,
2000).
Consistent with the view of Jensen (1993) that during the 1980s internal control
mechanisms are weak and ineffective, we find that stock ownership by officers and
directors of the divesting firms and ownership by the chief executive officer (CEO) are
significantly lower than ownership levels in the control firms. Even though low man-
agerial ownership suggests weak internal controls, we find evidence that shareholders
still benefit when managers own more shares and when there are more unaffiliated
outside directors on the board. Our analysis of insider trading produces our most in-
teresting result and suggests that preceding the asset sale insiders adjust their trading
activities to benefit from potential stock price increases. We find that shareholders
benefit more from the asset sale when insiders increase their stock holdings over the
two years leading up to the sale. Thus, knowing whether managers reach a given level
of ownership by way of selling or buying shares provides more information about
the alignment of interests than just the level of managerial ownership. Our evidence
is consistent with the view of Warther (1998) that boards are generally passive on
a day-to-day basis but act to discipline managers when firm performance reaches a
critical level. We also find that firms that divest assets are more involved in the market
for corporate control. Divesting firms are more than twice as likely as control firms
to acquire other firms in the two years preceding the divestiture.
2. Corporate governance and asset sales

With imperfect contracting, shareholders must rely on internal and external con-
trol mechanisms to ensure that managers exercise decision rights in ways that increase
2 We focus on asset sales where the cash proceeds could exacerbate agency problems. Another strand of
literature analyzes value creation from spin offs (e.g., Daley, Mehrotra, and Sivakumar, 1997; Krishnaswami
and Subramaniam, 1999; Desai and Jain, 1999) and carve-outs (Gleason, Madura, and Pennathur, 2006)
but they do not consider ownership structure in detail.
share value. Under the rubric of corporate governance, shareholders depend on mon-
itoring by the board of directors and managerial stock ownership as the primary
mechanisms to align managerial incentives and control agency problems, such as
overinvestment. When these mechanisms fail, perhaps because of ineffective boards
of directors, poorly structured compensation plans, or low stock ownership by man-
agers, shareholders must rely on external mechanisms such as monitoring by active
investors or the market for corporate control to restrain managers from pursuing
value-reducing strategies. In this section, we develop the relation between corporate
governance and the value effects of asset sales.
2.1. Board structure

Diffuse shareholders constrained by collective action problems must rely on
the board of directors to monitor and deter managers from implementing policies
that diverge from shareholder interests. Directors, however, are not perfect agents.
Conflicts arise because directors nominated by the CEO may be too sympathetic
toward the CEO’s interests (Monks and Minow, 1995), or employee directors who
are potential successors to a retiring CEO may be reluctant to challenge a CEO who
acts contrary to shareholder interests (Hermalin and Weisbach, 1992). Nonemployee
appointees may not provide effective monitoring because of financial ties to the firm,
such as consulting contracts or other arrangements to provide banking or legal services
to the firm, or board culture could prevent directors from aggressively monitoring
the CEO (Jensen, 1993). Director independence, therefore, along with the power and
willingness to discipline managers, plays a crucial role in the success of a firm’s
governance structure.
In this study, we hypothesize that unaffiliated outside directors will enhance the
effectiveness of internal controls by ensuring that the decision to divest assets is in
the interest of shareholders and that the proceeds from the sale will be used wisely
(board monitoring hypothesis). We base this on the model of Warther (1998) of board
behavior. Directors give managers wide latitude to run the company on a day-to-day
basis, which can make the board seem overly passive or ineffective, especially if the
firm suffers from poor performance. But when firm performance reaches a critical
point, the board will act to correct perhaps well-intentioned but suboptimal operating
policies or motivate managers to sell assets that they are reluctant to sell (Boot, 1992).
Forceful action and strong internal controls are more likely when the board is largely
independent of management. Fama and Jensen (1983) suggest that outside directors,
concerned about their reputation as effective monitors, are less likely to collude with
management to expropriate shareholder wealth and can arbitrate serious conflicts
that occur between the interests of managers and shareholders. Consistent with this
view, several studies (e.g., Weisbach, 1988; Rosenstein and Wyatt, 1990; Byrd and
Hickman, 1992; Brickley, Coles, and Terry, 1994; Cotter, Shivdasani, and Zenner,
1997) find that at the announcement of various corporate events, evidence supporting
the notion that monitoring by outside directors has a positive effect on shareholder
wealth. Fairchild and Li (2005) analyze firm performance after the appointment of
new directors and find evidence that suggests a positive relation between the quality
of newly hired directors and post-hiring stock returns.
2.2. Ownership structure

Shareholder gains from asset sales are consistent with the notion that the sale
corrects overinvestment, perhaps caused by weak internal control mechanisms. Jensen
(1993) argues that problems with internal controls arise because managers and outside
board members own little of the firm’s stock. Low ownership allows managers to
pursue their own agenda, such as increasing firm size, maximizing market share,
making wasteful acquisitions, or otherwise investing in low-return projects, at lower
cost to themselves. The incentives associated with substantial stock ownership by
managers (ownership incentive hypothesis) make overinvestment less likely and make
asset sales more likely to benefit shareholders (Lang, Poulsen, and Stulz, 1995).
A contrasting view of the relation between shareholder gains from asset sales
and managerial ownership suggests that gains will be larger when ownership is lower.
Under this view, when the firm announces that it will divest assets, low managerial
ownership signals the potential for large gains from removing negative synergies
that arise from weak managerial incentives (ownership signaling hypothesis). With
little interest in acting quickly, managers with low ownership would allow negative
synergies to accumulate, thus creating the potential for large gains when changes are
finally made. Under this view, the impetus to divest comes not so much from manage-
ment’s desire to increase shareholder wealth, but from the board of directors (along
the lines of Warther, 1998) or external factors such as economic shocks (Mitchell and
Muhlerin, 1996), active investors, or the threat of takeover.
Existing evidence relating managerial stock ownership and gains from divesti-
tures is mixed. Lang, Poulsen, and Stulz (1995) find that managerial stock ownership
has no explanatory power in their cross-sectional regressions of returns to asset sales.
Hite and Vetsuypens (1989) find a significant relation between managerial owner-
ship and returns for a sample of divisional management buyouts. Hirschey and Zaima
(1989) find higher returns to corporate sell-offs for closely held firms where insid-
ers control more than 5% of the stock than when insiders control less than 5%. Lee,
Rosenstein, Rangan, and Davidson (1992) report a significant cross-sectional relation
between insider ownership and returns to going private transactions, but no significant
relation for unit management buyouts. Thus, no clear-cut relation between divestiture
gains and managerial ownership emerges from these studies.
2.3. Insider Trading

We investigate insider trading activity of divesting and control sample firms
over the two years preceding the divestiture. The discussion of ownership structure
suggests that the relation between managerial ownership and divestiture gains could
be either positive or negative. Point estimates of managerial ownership may not pro-
vide sufficient information about management’s intention or expectation about the
upcoming divestiture to distinguish between these two alternatives. Insider trading
activity indicates whether managers arrived at the point estimate of ownership while
accumulating shares, thereby further aligning their interests with shareholders and
sending a positive signal, or liquidating shares, weakening the alignment of interests
and sending a negative signal.
John and Mishra (1990) model insider trading and capital expenditures as a
joint signal about firm performance. In their model, buying activity by managers of
growth firms along with capital expenditure announcements provide a positive signal
about the firms’ future. Therefore, we test an insider trading signaling hypothesis:
insiders increase their buying activity before asset sales that increase efficiency and
shareholder value (Hite, Owers, and Rogers, 1987) and decrease buying or continue
normal selling activity before asset sales that are intended to further managers’ per-
sonal objectives (Lang, Poulsen, and Stulz, 1995).3
2.4. External monitoring

Absent strong internal control mechanisms or the threat of takeover (Jensen
1991), shareholders must rely on external mechanisms such as monitoring by large
shareholders (Shleifer and Vishny, 1986) or institutional investors (Black, 1992) to
control agency costs. As examples of external monitoring, Hartzell and Starks (2003)
examine the relation between institutional ownership concentration and executive
compensation and suggest that institutions mitigate agency conflicts between share-
holders and managers. Denis, Denis, and Sarin (1997) show that the presence of
outside blockholders has a significant effect on the probability of executive turnover
and makes turnover more sensitive to firm performance. Brickley, Lease, and Smith
(1988) suggest that institutional investors provide valuable monitoring of manage-
ment through the voting process. Thus, we predict that asset sales benefit shareholders
more when external monitoring by institutional investors and outside blockholders is
strong.
3. Data and methods

We collect our divestiture sample from Mergers and Acquisitions. The sample
includes asset sales, but excludes spin-offs and equity carve-outs. We require that the
value of the transaction be listed, that the divestiture be reported in the Wall Street
Journal or Lexis-Nexis. The transaction also must have ownership structure and board
3 Jaffe(1974), Finnerty (1976), and Seyhun (1986) show that insiders can generate abnormal profits from
trading, and studies by Hirschey and Zaima (1989), Seyhun (1990), Karpoff and Lee (1991), and Lee,
Mikkelson, and Partch (1992) report that insiders adjust their trading before various corporate investing
and financing decisions.
structure reported in proxy statements for the year of the divestiture, returns available
from Center for Research in Security Prices (CRSP), and financial statement available
data from Compustat. We use Lexis-Nexis to review news reports, annual reports to
shareholders, and 10-K filings to learn how firms use asset sale proceeds. We collect
institutional ownership data from the Standard and Poor’s Stock Guide. Our sample
excludes firms in the financial sector.
For comparison, we create a control sample of firms that do not divest assets.
Control sample design requires a tradeoff between the desire to control for various
characteristics and the problems of fewer matches and increased cost of collecting
data as the number of criteria increases. Because our primary comparisons involve
managerial ownership, board structure, and investment activity, we select our control
sample firms by matching on two variables: firm size measured by the market value
of equity and the market-to-book ratio.4
We base our selection of firm size as a control variable on Demsetz and Lehn
(1985), who argue that managerial ownership should be more diffuse in larger firms
because of wealth constraints and risk aversion. They also suggest that managerial
ownership depends directly on volatility because the profit potential of ownership
increases with instability in the firm’s environment. We do not match on volatility,
however, but our tests show that stock return volatility estimated by the standard
deviation of daily returns over the 500 days preceding the divestiture does not differ
between samples.
We use market-to-book ratios because Morck, Shleifer, and Vishny (1988a),
McConnell and Servaes (1990), among others, show that Tobin’s q and ownership
are related. Following Chung and Pruitt (1994) we use the market-to-book ratio as a
proxy for Tobin’s q. Moreover, the market-to-book ratio is often used to measure a
firm’s investment opportunity set (Smith and Watts, 1992), and we would like to see
whether the investment behavior of divesting firms differs from firms with similar
opportunities. Moreover, matching by firm size and market-to-book ratios follows
the recent trend using these variables to cross-sectionally adjust for risk (e.g., Barber
and Lyon, 1997).
We identify a control firm by first finding all firms with market value of equity
within 80–120% of the divesting firm’s value; we then select the control firm with
the closest market-to-book ratio.
The final sample consists of 263 divestitures announced during 1981–1995. We
identify the use of proceeds for 114 of the 263 cases, including 67 cases where the
proceeds are used to pay down debt.
Data on insider trading activity come from the SEC’s Ownership Reporting Sys-
tem master tape provided by the U.S. National Archives and Records Service. Insider
4 We do not match on industry, which would require identifying the industry code at the asset sale date,
whereas Compustat lists only the most recent SIC code. Given that SIC codes change over time (Kahle
and Walkling, 1996), matching would be problematic, especially considering that sample firms undergo
major restructuring.
trading activity includes open market purchases and sales by officers, directors, and
beneficial owners of more than 10% of the common stock. We use net buying trans-
actions for each firm as our main indicator of insider trading activity. Net buying is
the number of open market buying transactions minus the number of open market
selling transactions.
We use Thomson Financial SDC Platinum to identify merger and acquisition
activity in the five years surrounding the asset sale.
Following Baysinger and Butler (1985), Byrd and Hickman (1992), and Brickley,
Coles, and Terry (1994), among others, we classify the selling firm’s directors based
on their economic or personal ties to the firm. We classify directors as inside if they
are current or past employees, or are related to the firm’s chief executive, or part of the
founding family. Directors who have a close but indirect relation with the firm such as
consultants, lawyers, or executives of firms with a business relationship with the firm
we classify as affiliated outside (or gray) directors. Otherwise, we deem directors
as independent unaffiliated outside directors, such as executives of unrelated firms,
private investors, or directors from outside the business community.
We calculate excess returns surrounding the divestiture announcement using
standard event study methods and estimate market-model parameters over a 240-day
period ending 60 days before the initial announcement of the divestiture.
4. Results
4.1. Sample characteristics
Table 1 presents basic information about the value of the transaction and share-
holder wealth effects surrounding the announcement of the divestiture. We divide the
sample by decades because of suggestions by Jensen (1991, 1993) that the market for
corporate control changed in the late 1980s along with the effectiveness of corporate
control mechanisms, and because Denis and Kruse (2000) find differences between
the 1980s and early 1990s in disciplinary actions after declines in firm performance.
The average divested asset has a value of $205 million (median $95 million). The
average transaction value and the value of the transaction relative to the firm’s equity
are about the same in the 1990s as in the 1980s, but the median transaction is smaller
($85 million versus $120 million) in the 1990s. Our sample selection process results
in a mean transaction value nearly four times larger than the Hite and Vetsuypens
(1989) report, and about twice the value in Lang, Poulsen, and Stulz (1995). Excess
returns over a two- (−1, 0) or three-day (−1, 1) window are roughly 0.6% and sta-
tistically significant, although only at the 10% level of significance in the 1990s.
Our announcement period returns are similar in magnitude to those found in earlier
studies of divestitures during the 1980s, but our 1990s results contrast with Muhlerin
and Boone (2000) who report announcement returns of 2.60% for asset sales dur-
ing 1990–1999. Their sample includes larger transactions by firms included in the
Value Line Investment Survey, and, as they show, wealth effects of the transaction
are directly related to the relative size of the transaction. Test results not in the table
Table 1
Excess returns at asset-sale announcement
Sample of 263 asset sales collected from various issues of Mergers and Acquisitions, 1981–1995. Value
of transaction is the reported price paid for the assets. Relative value is transaction value divided by the
market value of the divesting firm’s equity. Cumulative abnormal returns (CAR) are reported for two- and
three-day intervals surrounding the announcement day. z-Statistics are from Wilcoxon signed-ranks tests.
Mean Median
Panel A: All years (n = 263)
Value of transaction ($ million) 205.44 95.00

Relative value of transaction 0.07 0.03
Excess return of divesting firm
CAR (−1, 0) 0.560% 0.083%
t = 2.69∗∗∗ z = 1.49
CAR (−1, +1) 0.607% 0.206%
t = 2.54∗∗ z = 2.18∗∗
Panel B: Years 1981–1989 (n = 92)

CAR (−1, 0) 0.629% 0.204%
t = 2.41∗∗ z = 2.08∗∗
CAR (−1, +1) 0.680% 0.339%
t = 2.27∗∗ z = 2.22∗∗
Panel C: Years 1990–1995 (n = 171)

CAR (−1, 0) 0.522% −0.068%
t = 1.82∗ z = −0.34
CAR (−1, +1) 0.568% 0.276%
t = 1.72∗ z = 1.09
Asterisks indicate significance at the 1% (∗∗∗ ), 5% (∗∗ ), or 10% (∗ ) level.
indicate that returns and relative values in the 1980s are not statistically different
from those in the 1990s.
4.2. Stock ownership and board structure

Table 2, Panel A shows mean values of the ownership and board structure of
the divesting and matching control sample firms. Columns 1 and 2 show that the
divesting firms have significantly more directors, on average, than matching control
firms (12.28 versus 11.74), but have significantly less stock ownership by officers
and directors (6.84 versus 9.03%). The difference in ownership is primarily a result
370
Table 2
Stock ownership by officers and directors
Stock ownership by managers and directors of divesting firm and matching control sample firms. Directors grouped as insiders, affiliated outside (gray), and
unaffiliated outside directors. A sample of 263 asset selling firms and a control sample matched by firm size and market-to-book ratio.
Panel A: Means
Years 1981–1995 Years 1981–1989 Years 1990–1995

Difference Difference Difference
Divesting Matching t-statistic Divesting Matching t-statistic Divesting Matching t-statistic
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Market value of equity $6,239 $6,116 0.62 $3,309 $3,257 1.38 $7,815 $7,654 0.53
No. of directors 12.28 11.74 2.15∗∗ 13.29 12.29 2.26∗∗ 11.73 11.44 0.97
Ownership of directors 6.84% 9.03% −1.97∗∗ 8.49% 9.35% −0.47 5.996% 8.86% −2.07∗∗
Inside directors
Number 3.94 4.08 −0.73 4.96 4.75 0.64 3.40 7.71 −1.42
Ownership 5.57% 7.63% −1.91∗ 6.67% 7.59% −0.55 4.98% 7.61% −1.96∗∗
Insiders except CEO ownership 2.32% 2.99% −1.19 3.26% 3.20% 0.06 1.81% 2.88% −1.50
CEO ownership 3.26% 4.64% −1.56 3.24% 4.49% −0.70 3.17% 4.73% −1.43
Insiders as % of board 32.3 35.0 −2.24∗∗ 37.5 39.4 −0.88 29.5 32.6 −2.16∗∗
Unaffiliated outside directors
Number 6.52 5.82 3.47∗∗∗ 6.10 5.67 1.16 6.75 5.89 3.52∗∗∗
Ownership 0.82% 1.08% −0.80 1.19% 1.32% −0.19 0.62% 0.95% −1.00
Unaffiliated as % of board 52.8 48.7 2.92∗∗ 45.2 44.4 0.34 56.9 50.1 3.37∗∗∗
Affiliated outside directors
Number 1.81 1.84 −0.25 2.24 1.87 1.60 1.58 1.83 −1.46
Ownership 4.45% 0.31% 0.83 0.62% 0.33% 0.92 0.35% 0.30% 0.27
R. C. Hanson and M. H. Song/The Financial Review 41 (2006) 361–386
Affiliated as % of board 14.9 16.3 −1.27 17.3 16.1 0.64 13.6 16.4 −1.95∗
(continued )
Table 2 (continued)
Stock ownership by officers and directors
Panel B: Medians
Years 1981–1995 Years 1981–1989 Years 1990–1995

Difference Difference Difference
Divesting Matching z-statistic Divesting Matching z-statistic Divesting Matching z-statistic
Time frame (1) (2) (3) (4) (5) (6) (7) (8) (9)
Market value of equity $3,315 $2,332 1.13 $1,966 $1,932 0.12 $2,966 $2,716 1.52
No. of directors 12.00 11.00 2.77∗∗ 13.00 12.00 2.62∗∗ 12.00 11.00 1.42
Ownership of directors 1.06% 1.73% −2.62∗∗ 1.73% 2.15% −0.80 0.86% 1.61% −2.68∗∗
Inside directors
Number 3.00 3.00 0.45 4.00 4.00 0.80 3.00 3.00 0.90
Ownership 0.73% 1.13% −2.81∗∗ 1.12% 1.32% −0.41 0.71% 1.09% −2.61∗∗
Insiders except CEO ownership 0.28% 0.38% −1.39 0.33% 0.57% −0.43 0.26% 0.30% −1.44
CEO ownership 0.27% 0.36% −2.34∗∗ 0.20% 0.34% −1.85∗ 0.33% 0.37% −1.50
Insiders as % of board 30.8 33.3 −2.38∗∗ 35.7 40.0 −1.12 27.3 30.0 −2.07∗∗
Unaffiliated outside directors
Number 7.00 6.00 3.41∗∗∗ 7.00 6.00 1.29 7.00 6.00 3.26∗∗∗
Ownership 0.03% 0.04% −0.34 0.03% 0.03% 0.48 0.04% 0.04% −0.81
Unaffiliated as % of board 53.8 50.0 2.76∗∗ 46.7 46.4 0.34 60.0 50.0 3.09∗∗∗
Affiliated outside directors
Number 2.00 2.00 0.37 2.00 2.00 1.52 1.00 2.00 −1.42
Ownership 0.00% 0.00% 0.59 0.01% 0.00% 0.65 0.00% 0.00% 1.29
Affiliated as % of board 13.3 14.3 −1.31 14.3 13.8 0.48 12.5 14.3 −1.86∗
Asterisks indicate significance at the 1% (∗∗∗ ), 5% (∗∗ ), or 10% (∗ ) level.

371
of inside directors of divesting firms owning fewer shares than their counterparts in
the matching control firms (5.57 versus 7.63%, p = 0.06). CEOs of divesting firms
own a slightly lower percentage of shares (difference is significant at the 0.12 level)
than the CEOs of the matching control firms (3.26 versus 4.64%).
The percentage of unaffiliated outside directors on the board is significantly
higher for divesting firms (52.8%) than for matching control firms (48.7%). The
ownership evidence presented in columns 1 and 2 suggests that divesting firms have
weaker internal control mechanisms than control sample firms. Table 2 reports that
divesting firms have a higher percentage of unaffiliated outside directors on the board.
Although the board has a majority of unaffiliated directors, which should lead to more
effective monitoring, the board could be ineffective because, as Jensen (1993) argues,
directors own too few shares. Stock ownership by outside unaffiliated directors of
divesting firms is a trivial 0.82% over the entire period and only 0.62% during the
1990s. Jensen’s conjecture about weak and ineffective internal controls during the
1980s seems to apply to the early 1990s as well.
Ofek and Yermack (2000) report that options make up a substantial proportion
of a manager’s equity ownership and the incentives for top managers. The beneficial
ownership that we collect from proxy statements, however, includes direct ownership
and shares that could be acquired within 60 days pursuant to stock option awards,
which likely understates the total option portion of a manager’s equity ownership.
Thus, the lower managerial ownership levels for divesting firms shown in Table 2
could be misleading if divesting firms rely more on long-dated options to compen-
sate managers than do control sample firms. To investigate this assumption, we use
Compustat data to compare divesting and control sample firms’ number of common
shares reserved for conversion of options. Paired t-tests show that the mean number
of shares reserved for conversion as a fraction of total shares outstanding, over the
two years preceding the divestiture year, does not differ significantly between firms.
Thus, divesting firms do not rely more heavily on options to compensate managers
than do control sample firms, reinforcing the conclusion that divesting firms have
lower managerial ownership.
The results in Table 2, columns 4–9, suggest that divesting firms have smaller
boards in the 1990s than the 1980s. Yermack (1996), for example, suggests that smaller
boards are more effective, but the announcement period returns in Table 1 do not
support the conjecture that boards were more effective in the 1990s. Table 2 also shows
that the significant differences between divesting and matching firms’ managerial
stock ownership arose from the 1990s. In the 1980s, divesting firms have larger boards,
but there are no significant differences in ownership between divesting and matching
control sample firms. One interpretation is that weaker external monitoring by the
market for corporate control and lower inside ownership in the late 1980s (Jensen,
1993) lead firms to compensate with smaller, more effective boards. Consistent with
this view, Denis and Kruse (2000) find a decline in disciplinary control-reducing
events during the less active takeover period 1989–1992.
Our managerial ownership results are similar to those of Shivdasani (1993), who
reports that hostile takeover targets have boards with 29% inside directors (versus our
32.3%) and 59% unaffiliated outside directors (versus our 52.8%). For a control
sample of nontarget firms, insiders make up 33% (versus our 35.0%) and unaffiliated
outside directors make up 56% (versus our 48.7%) of the board. The corresponding
levels of ownership for unaffiliated directors are 0.82% and 1.95% for hostile targets
and nontargets, respectively, and 2.03% for the CEOs of hostile targets and 7.19%
for nontarget CEOs. Thus, firms that divest assets and firms that become takeover
targets have boards dominated by outside directors, and both have a higher proportion
of outside directors on the board than matched control sample firms. CEOs of firms
that sell assets or are targets of hostile takeover bids have lower ownership than
control sample firms, and CEOs of target firms have even lower ownership levels
than the CEOs of divesting firms (2.03 versus 3.26%). These results suggest that
stock ownership by the CEO affects whether the firm divests assets or ends up as
a takeover target, consistent with the view that low managerial ownership fosters
agency problems.5
We examine whether shareholders need both a strong board and substantial
stock ownership by managers to protect their interests. Table 3 reports stock return,
ownership composition, and value data by whether unaffiliated outside directors
make up more than half of the board. The results suggest that managerial stock
ownership and monitoring by the board are substitute mechanisms used to control
agency problems. For example, with a weak board, when unaffiliated outside direc-
tors make up less than half the board members, the evidence suggests that the firm
relies on managerial ownership to control agency costs. In this case, with a weak
board (< 50% columns) where outside directors constitute only 35.6% of the board
members, managerial ownership levels are high, 10.54% by officers and directors,
and 5.36% by the CEO.6 In contrast, when the board is dominated (56.7%) by unaf-
filiated outside directors (> 50% columns), and monitoring should be more effective,
managerial ownership is low, 3.88% by officers and directors, and 1.57% by the
CEO.
To more closely examine whether ownership and board monitoring are substi-
tutes, Table 4 presents a four-way classification based on stock ownership by officers
and directors and whether unaffiliated outside directors constitute more than half the
board. Consistent with the board monitoring and ownership incentive hypotheses,
we expect higher returns when unaffiliated outside directors dominate the board and
5 In a random sample of firms, Denis and Sarin (1999) report mean ownership by officers and directors of
15.74%, by the CEO of 7.22%, and that independent outside directors make up 40% of board members,
whereas 39% are inside directors.
6 Highmanagerial ownership could discourage outsiders from joining the board because their skills are
unneeded or unwanted. See Jensen (1993, p. 863) for a related anecdote about board culture.
374
Table 3
Stock ownership and board structure of divesting firms
Stock ownership and board structure of divesting firms when sample is split by unaffiliated outside directors constituting more than half the board of directors.
Cumulative abnormal returns (CAR) are reported for two- and three-day intervals surrounding the announcement of the divestiture. Sample of 263 cases from
1981 to 1995.
Median Median Kruskal-
Mean where Mean where t for where where Wallis
unaffiliated unaffiliated difference of unaffiliated unaffiliated χ 2 for
> 50% < 50% means > 50% < 50% difference
CAR (−1, 0) (%) 0.65 0.45 −0.46 −0.04 0.14 0.02
CAR (−1, +1) (%) 0.80 0.37 −0.89 0.37 0.05 0.20
Officer and director ownership (%) 3.88 10.54 3.65∗∗∗ 0.64 2.43 25.40∗∗∗
Number of inside directors 2.97 5.15 8.15∗∗∗ 3.00 5.00 61.78∗∗∗
Ownership by inside directors (%) 2.63 9.24 3.97∗∗∗ 0.50 1.54 28.58∗∗∗
Insider ownership except CEO (%) 1.06 3.88 3.27∗∗∗ 0.17 0.58 39.35∗∗∗
Stock ownership by the CEO (%) 1.57 5.36 2.92∗∗∗ 0.26 0.29 3.32∗
Number of outside directors 8.16 4.48 −14.24∗∗∗ 8.00 4.00 121.03∗∗∗
Ownership by outside directors (%) 1.09 0.49 −1.56 0.05 0.03 1.60
Number of gray directors 1.21 2.56 7.01∗∗∗ 1.00 2.00 47.37∗∗∗
Ownership by gray directors (%) 0.16 0.81 2.12∗∗ 0.00 0.01 23.93∗∗∗
Total number of directors 12.3 12.2 −0.33 12.0 12.0 0.01
Equity value ($M) 6975.8 5319.3 −1.38 3087.2 1612.2 8.30∗∗∗
Value of transaction ($M) 214.3 194.3 −0.53 86.8 111.0 0.09
Outside directors on board (%) 56.7 35.6 −22.8∗∗∗ 64.9 37.5 194.30∗∗∗
Asterisks indicate difference between groups is significant at the 1% (∗∗∗ ), 5% (∗∗ ), or 10% (∗ ) level.
Table 4
Board structure and outside blockholders of divesting firms
Four-way classification of two-day (−1, 0) announcement period excess returns and block ownership by
managerial ownership and by affiliation of outside directors. Managerial ownership is by all directors.
Blockholders own at least 5% of the firms stock and do not have board representation. Block presence
is the percentage of firms that have at least one blockholder. A sample of 263 divestitures from 1981 to
1995. Median values are in square brackets. z-Statistics are from Wilcoxon signed-ranks tests.
Proportion of Ownership > median Ownership < median

unaffiliated outside (median = 1.06%) (median = 1.06%)
directors Variable (1) (2)
1. Unaffiliated > 50% Excess return (%) 0.990 [−0.169] 0.460 [0.004]
(t = 1.76)∗ [z = 0.91] (t = 1.65)∗ [z = 1.04]
Market value ($M) 2732 [1052] 9254 [4379]
Value transaction ($M) 174 [63] 236 [105]
Block ownership (%) 10.69 [8.48]† 7.72 [0.00]
Block presence (%) 56.9† 45.3
No. of cases 51 95
2. Unaffiliated < 50% Excess return (%) 0.675 [0.301] −0.029 [−0.064]
(t = 1.52) [z = 1.36] (t = −0.08) [z = −0.52]
Market value ($M) 2539 [934] 11331 [6137]
Value transaction ($M) 164 [90] 260 [150]
Block ownership (%) 10.35 [6.45] 5.04 [0.00]†
Block presence (%) 56.3 27.0†
No. of cases 80 37
∗ Indicates significance at the 10% level.
† Mean and median values of block ownership and block presence in row 1, column 1 are significantly
different from values in row 2, column 2 at the 5% level or better.
managers have above median ownership (northwest cell in Table 4). Lower returns
should occur when control mechanisms are weakest. Here, unaffiliated outside di-
rectors make up less than half of the board and ownership by officers and directors
is below the median (southeast cell). Announcement period mean returns are sug-
gestive, showing a significant 0.990% (t = 1.76) in the northwest cell and −0.029%
(t = −0.08) in the southeast cell. Results not reported in the table, however, show
that the difference in these returns is not significant (t = 1.50), nor is the difference
in medians significant. Returns in the northeast cell (0.460%, t = 1.65) suggest that
even when ownership levels are low, having at least half the board made up of unaf-
filiated outside directors benefits shareholders. Interestingly, only 27% of divesting
firms in the southeast cell (weakest controls) have outside blockholders, which is
significantly fewer than the blockholder presence reported in the other three cells
(test statistics are not reported in the table). Blockholder ownership for the south-
east cell firms (5%) is significantly lower than firms in the northwest and southwest
cells.
4.3. Insider trading activity

We report insider trading activity for the divesting and control sample firms
over six-month and one-year periods and the change between periods in Table 5. We
follow previous literature (see footnote 3) and use the net number of open market
purchases and sales as our primary measure of trading activity, although we also
report values for the volume of shares traded and the volume relative to the number of
shares outstanding. Generally, net buying is negative over each six-month or one-year
period, indicating that insiders are net sellers of stock in the open market. Seyhun
(1986) reports that net selling is the norm except for very small firms. The trading
activity shown in Table 5 suggests, however, that insiders increased their buying
activity (from 0.738 to 0.856 transactions) and decreased their selling activity (from
2.407 to 1.772 transactions) during the six months (−1 to −6) immediately preceding
the asset sale compared with months −7 to −12 before the sale. Although buying
activity increased only slightly, there was a substantial decline in selling activity,
which resulted in a significant increase (10% level) in net buying activity. Seyhun
(1990) reports a similar pattern of insider trading activity in bidding firms before
takeovers. Net buying by managers before takeovers, or divestitures, suggests that
managers, on average, do not anticipate that the takeover, or divestiture, will harm
shareholders.
Table 5 also shows a highly significant increase in net buying activity from
year 2 to 1 as selling activity declines, although net buying remains negative (–2.586
in year −1). Although insiders at divesting firms exhibit significantly more net buying
activity than control firms before the divestiture, they still end up with significantly
lower managerial ownership the year of the divestiture (6.84 versus 9.03% shown
in Table 2). Moreover, the volume of shares traded show that insiders at control
firms sell over twice as many shares as insiders at divesting firms. Relative volume
figures suggest that the higher volume for control sample firms was not merely a
result of more shares outstanding. These volume figures suggest that the difference
in managerial ownership shown in Table 2 was even greater two years before the
divestiture. The implied change in managerial ownership leading up to the asset sale
provides a strong signal that shareholders should benefit from the sale. This dynamic
view of managerial ownership produces a new picture compared to what emerges
from focusing solely on point estimates of ownership.
The insider trading results in Table 5 are consistent with the insider trading sig-
naling hypothesis that managers used their private information in ways suggesting
that the divestiture would benefit shareholders. The results also show that the divesti-
tures are intended to improve operational efficiency (Hite, Owers, and Rogers, 1987)
and enhance shareholder value. The evidence does not suggest that, as an extreme
case of the financing hypothesis (Lang, Poulsen, and Stulz, 1995), managers divest
assets with the intent to use the proceeds to further their personal objectives at the
expense of shareholders.
Table 5
Insider trading activity by asset selling firms and control sample firms
Mean values for the number of insider trading transactions and net volume over various periods leading
up to the announcement of 263 divestitures from 1981 to 1995. Transactions are open market buying or
selling. Net buying is the number of purchase minus the number of sale transactions. Negative volume
indicates net shares sold. Volume is scaled by outstanding shares. Control sample firms are matched by
firm size and market-to-book ratio. Difference t-statistics test equality of means between divesting and
control firms.
No. of transactions Volume
Period relative
to announcement Buying Selling Net buying (000s) Scaled (%)
Months −1 to −6
Divesting firms 0.856 1.772 −0.916 −24015 −0.028
Control sample 0.753 2.148 −1.1395 −39806 −0.060
Difference t-stat 0.44 0.67 0.75 0.75 1.02
Months −7 to −12
Divesting firms 0.738 2.407 −1.669 −18222 −0.024
Control sample 0.475 2.570 −2.095 −44020 −0.096
Difference t-stat 1.41 0.25 0.60 1.17 2.03∗∗
Change between periods
Divesting firms 0.753∗ −5793 −0.004
Control sample 0.700 4214 0.036
Difference t-stat 0.08 0.59 0.97
Year −1
Divesting firms 1.593 4.179 −2.586 −42237 −0.051
Control sample 1.228 4.719 −3.490 −83826 −0.163
Difference t-stat 1.00 0.51 0.76 1.04 1.80∗
Year −2
Divesting firms 1.605 6.548 −4.943 −41978 −0.032
Control sample 1.278 5.875 −4.597 −104304 −0.127
Difference t-stat 0.69 0.46 0.23 1.40 2.28∗∗
Change between periods
Divesting firms 2.357∗∗∗ −258 −0.020
Control sample 1.106 20477 −0.029
Difference t-stat 1.13 0.90 0.23
Asterisks indicate that t-tests of change in mean net buying between periods or means between divesting
and control firms are significant at the 1% (∗∗∗ ), 5% (∗∗ ), or 10% (∗ ) level.
4.4. Control transfer activity

To assess whether divesting firms overinvest by acquiring other firms or are
subject to external monitoring, we examine their activity in the market for corporate
control over the four years surrounding the divestiture. Previous studies suggest that
divestitures correct overinvestment. For example, Kaplan and Weisbach (1992) and
John and Ofek (1995) suggest that firms divest assets to correct bad acquisitions and to
Table 6
Control transfer activities
Frequency of divesting firms and control sample firms being a bidder in a takeover attempt or a target
of a takeover attempt in the five years surrounding the divestiture year. Sample of 263 divesting firms
and control firms matched by size and market-to-book ratio. Panel A shows the number sample firms
that make acquisitions and the number of unrelated target firms acquired in the two years preceding the
divestiture and whether the firm continues as an acquiring firm or itself becomes a target firm in the
two years after the divestiture. Relatedness is based on four-digit SIC code matching. Panel B reports
buy-and-hold abnormal returns (BHAR) over the two years preceding the divestiture.
Panel A: Control transfer activity, divesting firms versus control sample
Before divestiture
(years −2 to 0)
After divestiture
Bidder (years 0–2)
Firm is a All targets Unrelated targets Target Bidder
Divesting firm 80 65 11 54
Control sample 31 20 3 39
χ2 87.80∗∗∗ 9.79∗∗∗ 21.58∗∗∗ 6.77∗∗∗
Panel B: Preceding two-year buy and hold abnormal returns
Unrelated Related t for

All Bidder target target difference
BHAR −0.142 −0.121 −0.188 0.173 1.96
(t = −2.96) (t = −1.66) (t = −2.47) (t = 0.87)
Number 263 80 65 15
∗∗∗ Chi-square test of equal proportions is rejected at the 1% level of significance.
become more focused by selling assets unrelated to core operations. Mitchell and Lehn
(1990) provide evidence that the market for corporate control plays a role in correcting
overinvestment. Their evidence suggests that firms that make poor acquisitions later
become good takeover targets.
Acquiring other firms can lead to overinvestment, especially if the target firm
operates in an unrelated industry.7 Table 6, Panel A reports the frequency at which
divesting and matching control firms are bidders in takeovers during the two years
preceding the divestiture. Divesting firms are more than twice as likely as control
firms to acquire other companies, although both have similar investment opportunity
sets (matched market-to-book ratios). The table shows that 30% (80/263) of divesting
firms are takeover bidders in the two years leading up to the divestiture, whereas
7 Sicherman
and Petway (1987) report that firms acquiring divested assets experience significantly lower
announcement returns if the acquired assets are unrelated.
only 12% (31/263) of control firms are. The difference in proportions is significantly
different from zero (p = 0.00). Consistent with the notion that acquisitions lead to
overinvestment, Table 6, Panel A shows that among the 80 divesting firms that are
bidders, 81% (65/80) acquire unrelated (based on four-digit SIC matching) targets
compared with less than 65% (20/31) of the control sample bidders. The difference
in proportions is significant (p = 0.00).
Table 6, Panel A also reports the extent to which divesting and control firms are
targets or bidders after the divestiture. In the two years after divestiture, the proportion
of divesting firms that are bidders declines by a third to 20.5% (54/263), whereas the
proportion of control firms that are bidders shows a slight increase to 14.8% (39/263).
At the same time, 4.1% (11/263) of divesting firms and 1.1% (3/263) of control firms
become targets of takeover activity. Again, the proportions are significantly different
(p = 0.00). By comparison, Denis and Kruse (2000) (p. 406) report for the years
1989–1992 an annual takeover rate of 2.5% over the three years after the onset of poor
performance. Our sample experiences a relatively high frequency of post-divestiture
takeover, similar to that of Denis and Kruse. Similar takeover rates suggest that the
disciplinary effect of the market for corporate control remains a potent factor for at
least two years after the management’s apparent attempt to improve performance by
divesting assets. Overall, the high acquisition rates in Table 6 are consistent with the
notion that some divesting firms overinvest by acquiring other firms, especially firms
in unrelated businesses, and that divestitures are intended to correct overinvestment.
Some managers, perhaps, decide to divest poorly performing assets to prevent the
firm from becoming one of the “good targets” analyzed by Mitchell and Lehn (1990),
but some managers are not successful.
We use the long-term stock performance of divesting firms to test whether these
firms are overinvesting by making poor acquisitions. Following Barber and Lyon
(1997), we calculate buy-and-hold abnormal returns as the difference in returns com-
pounded over the 500-day period preceding the divestiture between the divesting and
control sample firms. Table 6, Panel B reports that, on average, the 80 bidding firms
underperform control firms by 12.1% over the two years before the divestiture, better
than the 15.1% underperformance for the 183 nonbidding firms. The 65 bidders that
acquire unrelated assets underperform by 18.8%, whereas bidders that acquire related
assets outperform control firms by 17.3% over pre-divestiture period. Although not
all divested acquisitions represent failures (Kaplan and Weisbach, 1992), the 36.1%
difference in performance suggests that firms acquiring unrelated assets do not make
good acquisitions, and perhaps in these instances the divestiture is an attempt to
correct a mistake.
The results in Table 6 suggest that divesting firms are more likely to overinvest by
acquiring other firms, especially firms in unrelated businesses, perhaps because of the
free cash-flow problems suggested by Jensen (1986). Firms also may waste resources
on internally generated low-return projects. To investigate this issue, we compare
capital expenditure levels of divesting and control firms. Similar to Servaes (1994),
as our metric we use capital expenditures over year −2 to year −1 scaled by total
assets at year −2. Results not presented in the tables show, for example, that this ratio
for divesting firms (0.065) is not significantly different from control firms (0.070).
Moreover, the year −2 market-to-book ratio, as a proxy for investment opportunities,
for divesting firms (2.16) is not significantly different from control firms (2.23).
Thus, divesting firms and control firms face similar investment opportunities and
invest similar amounts. This evidence does not support the notion that divesting firms
overinvest in internally generated projects.
Servaes (1994) also considers overinvestment by takeover targets and finds lit-
tle or no evidence that firms become targets to correct overinvestment. Hendershott
(1996), however, finds some evidence of overinvestment by targets that undergo de-
fensive highly leveraged transactions, but not in other unsuccessful or successful
takeovers. Thus, evidence of internal overinvestment remains elusive, although per-
suasive arguments have been made that divestitures and takeovers are mechanisms to
correct overinvestment.
4.5. Regression analysis

In Table 7, we report the results of cross-sectional regressions with the two-day
(−1, 0) announcement excess return as the dependent variable. Regression 1 shows
that stock ownership by officers and directors has a significant (p = 0.07) effect
on returns as does the proportion of unaffiliated directors on the board (p = 0.04).
The estimates are consistent with the ownership incentive and board monitoring hy-
potheses that suggest higher levels of managerial stock ownership and a stronger
board help ensure that the proceeds from the divestiture be used to benefit share-
holders. The results do not support the contrasting ownership signaling hypothesis
that gains are larger when managerial ownership is lower. Managerial ownership
and board structure are significantly related to shareholder gains, although the lower
ownership levels in Table 2 suggest weak internal controls. Our results support the
view that shareholders expect to benefit when managers own more shares and when
unaffiliated outside directors make up a higher proportion of the board.
Regression 2 includes a dummy variable that indicates whether the divesting
firm is acquired within the two years after the divestiture. We use this dummy as a
proxy for an active market for corporate control because it suggests that the firm was
“in play” and subject to external monitoring. The dummy underestimates the number
of firms “in play” because it does not include firms considered as possible acquisition
targets but passed over. The coefficient of this dummy variable is significant (p =
0.09), suggesting that shareholder gains are higher when the firm is subject to external
monitoring.8 The 11 divesting firms that are acquired within the two years after the
8 To adjust for the unobserved “in play” firms we use a logistic regression to estimate the predicted
probability of becoming a target, and replace the dummy variable that denotes acquisition within two years
with the predicted probability of becoming a target. In results not shown, the coefficient of this variable
remains marginally significant (p = 0.08).
Table 7
Regression analysis of two-day market-model abnormal returns around 263 asset-sale announcements, 1981–1995
Net buying dummy equals 1 if there is net insider buying between years –2 to –1 and between years –1 to 0. Post-acquisition dummy equals 1 if the divesting
firm is acquired within the two years after the asset sale. Prior acquiring firm dummy equals 1 if the firm acquires assets within two years before the asset sale.
p-values are in parentheses.
Explanatory variable 1 2 3 4 5 6
Constant −0.990 (0.14) −1.071 (0.11) 1.194 (0.07) −0.931 (0.17) −0.669 (0.36) −1.113 (0.11)
Ownership by officers and directors 0.027 (0.07) 0.027 (0.07) 0.011 (0.45)
Fraction of outside directors 2.327 (0.04) 2.364 (0.04) 2.383 (0.03) 2.126 (0.07) 2.326 (0.06) 2.196 (0.06)
Stock ownership by inside directors 0.031 (0.07) 0.028 (0.10) 0.029 (0.09)
Stock ownership by gray directors −0.095 (0.30) −0.089 (0.34) −0.093 (0.32)
Stock ownership by outside directors 0.058 (0.34) 0.054 (0.38) 0.059 (0.33)
Ownership × net buying dummy 0.179 (0.00)
Post-acquisition dummy 1.742 (0.09) 1.918 (0.05) 1.682 (0.10) 1.650 (0.11) 1.646 (0.11)
(firm acquired post-sale = 1)
Change in leverage (−1 to 1) −0.005 (0.29) −0.004 (0.34) −0.005 (0.25) −0.005 (0.24) −0.005 (0.21)
Relative value of transaction (×0.0001) 5.753 (0.00) 5.755 (0.00) 5.577 (0.00) 5.674 (0.00) 5.627 (0.00) 5.333 (0.00)
Institutional ownership −0.529 (0.27)
Use of proceeds dummy (pay down debt = 1) 0.582 (0.22)
Prior acquiring firm dummy (acquirer = 1) 0.134 (0.77)
Market-to-book ratio −0.015 (0.65)
1990s dummy (1990s = 1) −0.111 (0.81)
Adjusted R2 0.054 0.062 0.145 0.062 0.060 0.057
Regression p-value 0.001 0.001 0.000 0.001 0.003 0.005
381
divestiture have significantly higher CEO ownership than the other divesting firms
(10.06 versus 2.96%, difference t = 2.20). This is consistent with the Morck, Shleifer,
and Vishny (1988) contention that high stock ownership by the CEO eases transfer
of control in friendly takeovers. Thus, high CEO ownership levels among the firms
that later become takeover targets suggest that the takeovers are not disciplinary in
nature but motivated by potential synergies.
Regression 3 incorporates the effect of insider trading activity on announcement
period returns by including an interactive ownership × net buying dummy variable.
The net buying dummy equals one if net buying increases over the two years preceding
the divestiture. This dummy indicates firms in which managers, before the divestiture,
adjusted their usual trading activity to benefit from potential stock price increases. In
these firms, changes in trading activity suggest that managers are concerned about
the shareholder wealth effects of their actions, and imply a close alignment of man-
ager and shareholder interests. Consistent with the insider trading signaling hypoth-
esis, estimates show that the coefficient of this interactive term is highly significant
(p = 0.00), whereas the coefficient of ownership by officers and directors is no longer
significant (p = 0.45). Together, these estimates indicate that managerial stock own-
ership has a strong positive influence on returns only when insiders increase their
buying activity or decrease their selling activity leading up to the divestiture. The
results suggest that static point estimates of ownership by officers and directors con-
vey only an incomplete picture of the dynamics between ownership and managerial
decisions. A fuller picture emerges when point estimates of ownership are combined
with information about changes in the level of ownership leading up to the event.
Thus, how a manager arrives at a given level of ownership is more informative about
the relation between their ownership level and wealth effects of their actions than
merely the level of ownership. Our regression estimates are consistent with John and
Mishra (1990) who model insider trading and capital expenditures as a joint signal
about the firm’s prospects. Insider trading activity, therefore, adds a dynamic element
to ownership structure by showing how managers, at the margin, adjust ownership
levels in anticipation of the wealth effects of managerial decisions.
In regression 4, we separate ownership by officers and directors into three groups
depending on the director’s affiliation with the firm. Regression estimates show that
only stock ownership by inside directors has significant (p = 0.07) explanatory value.
Although divestiture gains are not related to ownership by nonmanager (gray and
outside) directors, these gains are significantly related to the proportion of outside
directors on the board consistent with the board monitoring hypothesis. The lack
of explanatory power for nonmanager director ownership is consistent with Byrd
and Hickman (1992) who report negative, but insignificant, coefficients for outside
director ownership in regressions of tender offer bidder announcement returns and
Cotter, Shivdasani, and Zenner (1997) who find positive but insignificant coefficients
in regressions of tender offer target gains. Ownership levels by nonmanager directors,
as Jensen suggests, could be too low to make a difference. But our results suggest that
the presence of outsiders on the board does make a difference. The difference could
arise because a higher proportion of outside directors make it easier for an otherwise
passive board to coalesce and take action (Warther, 1998), or perhaps as Fama and
Jensen (1983) argue, because outside directors are concerned about their reputation
as effective monitors.
In regression 5, we include an institutional ownership variable to examine
whether monitoring by institutional investors help explains announcement period
returns, and a dummy variable that equals one if the asset sale takes place in the
1990s. Although not reported in the tables, institutional ownership averages 52.5%,
similar to the 53.1% in Hartzell and Starks (2003) and the 50.9% in Agrawal and
Knoeber (1996), but higher than the 33.3% found by Denis, Denis, and Sarin (1997)
and 32.9% reported by Brickley, Lease, and Smith (1988). The estimated coefficients
of institutional ownership are negative but not statistically different from zero. This
relation is consistent with Agrawal and Knoeber who report no significant relation
between institutional ownership and firm performance measured by Tobin’s q. Thus,
neither variable has marginal explanatory power.
Finally, in regression 6, we include a dummy variable that equals one if the
proceeds from the sale are used to pay down debt, a dummy variable that equals
one if the selling firm made an acquisition in the two years before the sale, and a
variable to control for the market-to-book ratio. Although not reported in the tables,
we find significant positive returns (1.15%, t = 2.14) when the proceeds are used to
pay down debt, consistent with the financing hypothesis of Lang, Poulsen, and Stulz
(1995). In regression 6, unlike Lang, Poulsen, and Stulz, but consistent with John and
Ofek (1995), we find that the use of proceeds dummy is not significant (p = 0.22).
Thus, the use of proceeds provides no explanatory power beyond that provided by
the regression’s ownership and board structure variables.
5. Conclusions
In this study, we use a sample of asset sales to investigate the effect of board and
ownership structures as internal control mechanisms. Weak internal control mecha-
nisms can lead to overinvestment, and subsequent divestitures help correct this prob-
lem. Consistent with the view of Jensen (1993) that internal controls are weak and
ineffective during the 1980s (and by extension the early 1990s), divesting firms have
significantly lower managerial stock ownership than control firms. We also find ev-
idence that external control mechanisms play a role in asset sales. Divesting firms
are more than twice as likely as control firms to be involved in takeover activity as
bidders before the divestiture and more likely to acquire unrelated assets before the
divestiture.
The results show that shareholder gains from asset sales are related to the strength
of internal control mechanisms. Shareholders benefit the most when managerial own-
ership is high and the board simultaneously is dominated by outsider directors, but
shareholders still benefit when at least one of these mechanisms holds. Our analysis
of insider trading suggests that insiders adjust their normal trading patterns before
the asset sale in a way to benefit from potential increases in stock price. Shareholders
benefit more from the asset sale when insiders increase their holdings by trading in
the two years leading up to the sale. The results show that managerial ownership
is significantly related to announcement returns only when insiders increase their
net buying activity before the sale. Thus, how managers arrive at a given level of
ownership provides more information than the level of ownership alone.
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The Financial Review 41 (2006) 361--386

Corporate Governance and Asset Sales:

JEL Classifications: G32, G34

∗ Corresponding author: Department of Accounting and Finance, College of Business, Eastern

2. Corporate governance and asset sales

2.1. Board structure

2.2. Ownership structure

2.3. Insider Trading

2.4. External monitoring

3. Data and methods

Value of transaction ($ million) 205.44 95.00

Panel B: Years 1981–1989 (n = 92)

Panel C: Years 1990–1995 (n = 171)

Value of transaction ($ million) 202.07 85.40

4.2. Stock ownership and board structure

Years 1981–1995 Years 1981–1989 Years 1990–1995

Years 1981–1995 Years 1981–1989 Years 1990–1995

Asterisks indicate significance at the 1% (∗∗∗ ), 5% (∗∗ ), or 10% (∗ ) level.

Proportion of Ownership > median Ownership < median

4.3. Insider trading activity

4.4. Control transfer activity

Panel B: Preceding two-year buy and hold abnormal returns

Unrelated Related t for

4.5. Regression analysis

Donaldson, G., 1984. Managing Corporate Growth, New York: Praeger.

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