Why Executives Shy Away from Divestitures  619
­expansion to maturity. Different skills and capabilities are needed to man-
age the business well at different moments in its life cycle: from a focus on 
innovation in the start-up phase, when a viable business idea and platform 
are created, to cost management skills at maturity, when efficiency is the key 
driver of success. Many corporations lack the full breadth and depth of skills. 
Typically, they excel in only a few capabilities, which also tend to be fairly 
static over time. Businesses ripe for divestiture could be at any stage in their 
life cycle and might well include a profitable, cash-generating business or a 
business with relatively high growth potential.
A common misperception about divestments is that they are an easy so-
lution for undervaluation in the stock market. Some managers interpret the 
positive excess returns to divestment announcements as a confirmation that 
the divestment exposes value the market had overlooked. That interpretation 
is wrong. It is often based on a misleading “sum of the parts” analysis, show-
ing that the current market value of the company is smaller than the sum of 
the values of its individual business. Unfortunately, the analyses often rely on 
valuation multiples of industry peers with higher performance or from differ-
ent sectors than the company’s businesses. When the analysis uses true peers, 
the conglomerate discount typically disappears (see Chapter 19).
Why Executives Shy Away from Divestitures
Although an active portfolio approach recognizes the value to be created from 
divestitures, most executives seem to shy away from initiating them. Looking 
at the 690 companies that remained in the global top 1,000 during the period 
from 2000 until 2013, almost 60 percent did not execute in any single year di-
vestitures that exceeded 5 percent of their market value. About 20 percent of 
the companies had only one year out of the 14 in which divestments amounted 
to at least 5 percent of their value. The previously mentioned McKinsey study 
of 200 U.S. companies found that at least 75 percent of the transactions were 
made in reaction to some form of pressure, such as underperformance of the 
corporate parent, the business unit, or both.
When underperformance eventually becomes transparent to the mar-
ket, investors exert continuous pressure on the corporation to divest. Aca-
demic research finds that companies that decided to sell assets tended to be 
poor performers and highly leveraged, suggesting that most voluntary asset 
sales are reactive rather than part of a proactive divestiture program.13 Sev-
eral publications have confirmed that parent companies tend to hold on to 
13 L. Lang, A. Poulsen, and R. Stulz, “Asset Sales, Firm Performance, and the Agency Costs of Manage-
rial Discretion,” Journal of Financial Economics 37 (1994): 3–37.

620  Divestitures
­underperforming businesses too long, waiting until they have to respond to 
economic, technological, or regulatory shocks.14
In our experience, many managers dislike divestitures because these trans-
actions could reduce the company’s earnings per share, price-to-earnings ratio 
(P/E), or other performance indicators. However, if the business is worth more 
to an outsider or as an independent company, the divestiture will create value 
and should be pursued. The example in Exhibit 32.3 illustrates this.
The company described in the left side of the exhibit can raise $550 million 
in cash from a divestment of a mature business unit. This unit has a relatively 
high return on invested capital (ROIC) but limited growth potential. The value 
of the business to the company is estimated at $450 million, so that selling it at 
$550 million clearly creates value for the company. Any resulting changes in 
14 See, for example, Mulherin and Boone, “Comparing Acquisitions and Divestitures”; D. Ravenscraft 
and F. Scherer, Mergers, Sell-Offs, and Economic Efficiency (Washington, DC: Brookings Institution, 1987), 
167; and M. Cho and M. Cohen, “The Economic Causes and Consequences of Corporate Divestiture,” 
Managerial and Decision Economics 18 (1997): 367–374.
Exhibit 32.3  Earnings Dilution through Divestitures
$ million
Use of proceeds
Company
Divested 
business unit
Hold cash
Debt 
repayment
Share buyback
Value of operations
 2,800 
 450 
 2,350 
 2,350 
 2,350 
Cash
 – 
–
 550 
–
 – 
Enterprise value
 2,800 
–
 2,900 
 2,350 
 2,350 
Debt
 (600)
–
 (600)
 (50)
 (600)
Market value of equity
 2,200 
–
 2,300 
 2,300 
 1,750 
Shares outstanding
 100.0 
–
 100 .0
 100.0 
 76.1 
Share price
 22.0 
–
 23.0 
 23.0 
 23.0 
Invested capital
1,800
150
1,650
1,650
1,650
EBIT
236.0 
50.0 
186.0
186.0
186.0
Interest income (2%)
 – 
 – 
 11.0 
 – 
 – 
Interest expense (6%)
 (36.0)
 – 
 (36.0)
 (3.0)
 (36.0)
Pretax income
 200.0 
50.0 
 161.0 
 183.0 
150.0
Taxes (25%)
 (50.0)
 (12.5)
 (40.3)
 (45.8)
 (37.5)
Net income
 150.0 
 37.5 
 120.8 
 137.3 
 112.5 
Earnings per share, $
 1.50 
–
 1.21 
 1.37 
 1.48 
P/E
 14.7 
14.7
 19.0 
 16.8 
 15.6 
Earnings yield, %
6.8
6.8
5.3
6.0
6.4
Pretax ROIC, %
13
33.3
11.3
11.3
11.3
Operating value/EBIT
11.9
9.0
15.6
12.6
12.6