Why discontinue operations? Interrelated elements of the corporate focus hypothesis

The purpose of this paper is to reexamine the corporate focus hypothesis to establish the characteristics of firms that discontinue operations. The authors concentrate on four interrelated elements of the hypothesis, diversification, performance, financial constraint and market-based risk measures. The authors also examine whether firms reporting positive- or negative-valued discontinued operations have different characteristics.

Analyzing discontinued operations provides a broad sample of strategically important exit decisions using a variety of different disposal methods. The authors use logistic regression models to explore whether the elements of the corporate focus hypotheses, and interactions between them, explain decisions to discontinue operations, and also the differences between firms making negative- and positive-valued announcements.

Firms that discontinue operations are more diverse, with weak operating performance, higher financial constraints and perform poorly in financial markets. Interrelationships between these factors strongly affect exit decisions. Companies reporting negative-valued discontinued operations are smaller, make lower capital investments and face greater cash constraints and market risk. Those announcing positive-valued discontinuations are larger and make higher payouts and capital expenditures. Their overall performance is weaker than for control firms, but clearly superior to companies discontinuing negative-valued operations.

Discounted operations represent a wide range of exit decisions. They provide a much larger sample than most previous studies of divestitures. The authors include β, the Sharpe ratio, cash holdings, payouts to shareholders, capital expenditures and also cross-product terms between the elements of the corporate focus hypothesis, all of which have received little attention in prior research. There are significant differences between firms announcing positive and negative-valued discontinued operations.