The value implications of restrictions on asset sales

• Author: H. Gregory Waller,Miroslava Straska,Valeriy Sibilkov
• Published date: 01 September 2013
• DOI: http://doi.org/10.1016/j.rfe.2013.04.001
• Date: 01 September 2013

The value implications of restrictions on asset sales

Valeriy Sibilkov

a,1

, Miroslava Straska

b,2

, H. Gregory Waller

b,

⁎

a

Sheldon B. Lubar School of Business, University of Wisconsin —Milwaukee, Milwaukee, WI 53201, United States

b

School of Business, Virginia Commonwealth University, Richmond, VA 23284, United States

abstractarticle info

Article history:

Received 30 October 2010

Accepted 2 February 2013

Available online 12 April 2013

Keywords:

Asset sales

Secured debt

Agency costs

Operating flexibility

This paper examines the effect of restrictions over asset disposition, measured by the ratio of secured debt to fixed

assets, on firm value. We find evidence consistentwith two non-mutually exclusive hypotheses. (1) Restrictions on

the disposition of assets reduce firm value by limiting a firm's ability to restructure assets or to raise funds to finance

higher NPV projects. (2) Restrictions on asset disposition increase firmvalue by limiting agency costs of managerial

discretion over uncommitted assets. The nete ffectof restrictions over asset disposition on firm value is determined

by potential agency problems and the need for operating flexibility.

© 2013 Published by Elsevier Inc.

1. Introduction

Existing studies document that the announcements of asset sales are,

on average, associated with positive abnormal stock market returns for

the selling firm.

3

The theory underlying this empirical observation holds

that asset sales facilitate the transfer of assets from relatively less efficient

users to relatively more efficient users and the selling firm benefits from

theincreaseinefficiency (Hite, Owers, & Rogers, 1987). An alternative

theory related to asset sales, which Lang, Poulsen, and Stulz (1995) call

the “financing hypothesis”holds that self-interested managers value

firm size and control, even at the expense of shareholders' wealth. Conse-

quently, managers sell assets to raise capital to finance activities preferred

by managers only when less costly sources of funding are not available.

Two key implications of the financing hypothesis are that, similar to free

cash flows from operations, the cash proceeds from asset sales represent

a source of discretionary cashfor managers and that the agency costs as-

sociated with the managerial discretion over this particular source of cash

can be costly to shareholders.

Consistent with the efficiency theory of asset sales, several studies

suggest that the ability to sell or restructure fixed assets, which we refer

to as operating flexibility, can be valuable to firms (Denis & Denis, 1995;

Denis & Sarin, 1999; Maksimovic & Phillips, 2001). Additionally, Bates

(2005) shows that the likelihood of proceed retention from an asset sale

increases with firm growth opportunities, and when the proceeds are

retained, the announcement returns are marginally higher for firms

with higher growthopportunities.

However, the positive valuation effects of both asset sales, per se, and

operating flexibility may be offset, or reversed, due to what Lang et al.

(1995) refer to as the agency costs of managerial discretion. Lang et al.

(1995),Allen and McConnell (1998),andBates (2005) report that

when the selling firm retains the proceeds from an asset sale, as opposed

to paying them out to investors, the average announcement returns are

lower and often insignificant. DeAngelo, DeAngelo, and Wruck (2002)

provide a case study as an example that managers can liquidate assets

to fund losing operations, thereby destroying shareholder wealth and

Morellec (2001) suggests that the easier it is for managers to sell assets,

the greater are the costs of managerial discretion.

From the literature on this topic, the ex ante prediction for the valua-

tion effect of an asset sale is that it should be value-enhancing for the

shareholders of the selling firm. As noted in Lang et al. (1995) the positive

stock market reaction to the completion of the sale of an asset is good

news about the value of the asset but in the presence of agency costs of

managerial discretion, shareholders do not capture all of that value.

Thus, the announcement effects of asset sales should be positive, on aver-

age, but less so in the presence of agency costs of managerial discretion.

What is less clear, is how restrictions on asset sales affect firm value. On

one hand, restrictions on asset sales can be value-enhancing if they miti-

gate the costs of managerial discretion. On the other hand, they can be

value-reducing if they limit a firm's ability to restructure its asset base

or raise funds to pursue higher-valued positive NPV projects. In this

paper, we examine how r estrictions on asset sales affect firm v alue.

We consider two non-mutually exclusive hypotheses, the operating

flexibility hypothesis and the agency hypothesis. The operating flexibility

hypothesis holds that the ability to restructure assets to adapt to changing

business conditions is valuable. Thus, this hypothesis predicts that restric-

tionsonassetsaleshaveanegativeeffectonfirm value. The agency

Review of Financial Economics 22 (2013) 98–108

⁎Corresponding author. Tel.: +1 804 828 3365.

E-mail addresses: sibilkov@uwm.edu (V. Sibilkov), mstraska@vcu.edu (M. Straska),

hgwaller@vcu.edu (H.G. Waller).

1

Tel.: +1 414 229 4369.

2

Tel.: +1 804 828 1741.

3

See for example, Alexander, Benson, and Kampmeyer (1984),Hite et al. (1987),

Jain (1985),Lang et al. (1995),Allen and McConnell (1998), and Bates (2005).

1058-3300/$ –see front matter © 2013 Published by Elsevier Inc.

http://dx.doi.org/10.1016/j.rfe.2013.04.001

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