Strategic Corporate Finance: Applications in Valuation and Capital Structure

FINANCIAL POLICY CONSIDERATIONS

In addition to incentive compensation policies, financial policies (financial liquidity, financial leverage, and shareholder distributions) may need to be recalibrated in the face of a divestiture. Furthermore, a relationship exists between financial policies and the divestiture methods employed.

Greater financial liquidity is needed for businesses with more volatility in their operating cash flows or with a weak outlook. Liquidity is more similar to comparable companies than to the parent. Subsidiary liquidity is generally higher than the parent, for cases of spin-offs and IPOs. IPO subsidiaries tend to have the highest liquidity, suggesting more disparate prospects for growth and volatility between the IPO parent and IPO sub. IPO parents exhibit lower liquidity than spin-off parents, which may partially explain the choice of IPO versus spin-off.

Financial leverage is typically less appropriate for growth. Divested subsidiaries are frequently less levered than the parent but similarly levered to comparable firms. IPO subs tend to be the least leveraged, again suggesting the most disparate growth prospects between the IPO parent and subsidiary. IPO parents are slightly more leveraged than spin-off parents, again suggesting the attraction of raising proceeds.

Shareholder distributions such as dividends and share repurchases tend to be less appropriate for growth-oriented businesses, where ostensibly, the capital should be reinvested in the growth ...