Strategic Management Journal, Vol.

18, 77–83 (1997)

RESEARCH NOTES AND COMMUNICATIONS

AGENCY CONFLICT AND CORPORATE STRATEGY:

THE EFFECT OF DIVESTMENT ON CORPORATE
VALUE
PETER WRIGHT
Fogelman College of Business and Economics, University of Memphis, Memphis,
Tennessee, U.S.A.
STEPHEN P. FERRIS
College of Business and Public Administration, University of Missouri—Columbia,
Columbia, Missouri, U.S.A.

Among the various stakeholders of a firm, senior managers are the most likely targets for
private and public political pressures. Other stakeholder groups are less visible and may be
perceived as less influential in corporate strategy formulation and implementation. In some
situations, consequently, senior executives may adopt corporate strategies in response to political
pressures even if these strategies may be costly to shareholders. In this study, a special case
is examined: the effect of divestment of South African business units on firm value. Using data
from 1984 through 1990, we examine the impact that announcements of divestments have upon
the stock return behavior of publicly traded firms. Our results indicate that significant and
negative excess returns accrue to shares of companies announcing divestments of South African
operations. These results are supportive of the premise that noneconomic pressures may
influence managerial strategies rather than value-enhancement goals.

Valuable insights have been provided on the sub-
ject of corporate divestment from a variety of
perspectives. Earlier works concentrated on con-
tingencies which required divestments: in situ-
ations where a business unit drains resources from
other, more profitable units (Salter and Weinhold,
1979), where the unit is not as efficient as alterna-
tives in the marketplace (Dundas and Richardson,
1980; Williamson, 1975), or when the business
is in its decline phase (Harrigan, 1979).
Divestment is also implied in cases where the
unit’s interdependence with other units is not
synergistic or its competitive position is weak
(Greiner, 1972; Scott, 1973).
More recently, corporate divestments of the
Key words: agency theory; corporate divestment; cor-
porate performance; firm value
1970s and the 1980s have been examined. Rav-
enscraft and Scherer (1987) conclude that many
of the divestments in the 1970s and the 1980s
were motivated by the underperformance of busi-
nesses acquired in the 1960s. Others report that
a portion of acquisitions made in the 1970s and
the early 1980s were also unsatisfactory and often
divested by the latter 1980s (Kaplan and Weis-
back, 1990).
Select authors have suggested that the
underperformance of a number of corporations
has been due to the unrelatedness of their units
(Porter, 1987; Shleifer and Vishny, 1991). In
response, many of the takeovers in the 1980s
have been characterized as acquisitions which
were followed by sell-offs of previously acquired
unrelated businesses (Shleifer and Vishny, 1991)
or those leveraged takeovers by the managers
themselves which were then pruned by substantial

CCC 0143–2095/97/010077–07 Received 17 November 1994

 1997 by John Wiley & Sons, Ltd. Final revision received 28 August 1995
78 P. Wright and S. P. Ferris
sell-offs of assets (Bhagat, Shleifer, and Vishny,
1990; Kaplan, 1990).
The above studies have advanced our under-
standing of corporate divestments which are prim-
arily economically motivated. Other works have
examined corporate strategies in the context of
agent–principal relationships. Specifically, agency
theory has been explored via diversification,
reverse diversification, and downsizing strategies
(e.g., Amihud, Lev, and Travlos, 1990; Bethel
and Liebeskind, 1993; Blackburn, Lang, and
Johnson, 1990; Bowman and Singh, 1993; Com-
ment and Jarrell, 1992; Franks, Harris, and Tit-
man, 1991; Singh, 1993). Our examination is an
extension of the agent–principal theory as applied
to the issue of corporate divestment. The contri-
bution of this study, moreover, is that its focus
is on another dimension of agency theory which
we have framed as our research question: ‘Do
private and public political forces determine cor-
porate strategy?’
According to Jensen and Murphy (1990), cor-
porate strategies which increase (decrease) a
firm’s market value by millions of dollars may
only marginally affect the financial benefits of
top executives. Moreover, these authors conclude
that the incentives of top managers may be inde-
pendent of their performance. Consequently, they
argue that private and public political forces often
drive managerial strategies rather than a goal of
value maximization. If the financial incentives of
top executives are indeed independent of their
performance, top executives may tend to adopt
strategies which are beneficial to themselves even
if these strategies may be costly to other stake-
holders, particularly shareholders.
Similar to Jensen and Murphy (1990), we pre-
sume that under some circumstances noneconomic
forces may influence corporate strategy. We focus
our study on a special case: corporate divestments
of South African operations. More specifically, we
examine the impact that public announcements of
divestment of South African operations have on
the stock return behavior of publicly traded firms
in the context of a principal–agent relationship.
Prior to July 10, 1991, when it was announced
that all U.S. economic sanctions against South
Africa would end, there was a buildup of private
and public pressure to divest U.S. business inter-
ests in that country (Erasmus, 1994; Ford, 1994).
The pressure to divest resulted from the moral
outrage that Americans felt in response to the
treatment of black South Africans by the minority
white South African government (Ennis and Par-
khill, 1986).
Many of the proponents of divestment, how-
ever, failed to realize that a number of American
business interests in South Africa not only were
profitable, but also economically, politically, and
socially beneficial to black South Africans
(Erasmus, 1994; Ford, 1994; Lashgari and Gant,
1989). Some of the American firms had a record
of equal pay for equal work and provided the
best desegregated working conditions in South
Africa. Also, U.S. business and government
groups served as influential forces in reforming
the government of South Africa throughout the
1980s and the early 1990s.
In order to analyze the impact of divestment
announcements of South African operations on
stock prices, an event study methodology is
employed. If divestment announcements are made
as a result of agency conflicts and are perceived
to be economically costly, firms’ stock prices
should react negatively to such announcements.
Alternatively, if such announcements are mot-
ivated by value enhancement goals, the market
impact of these announcements should be positive
for stock prices. That is, if the South African
unit represents a negative net present value
investment, then its divestment announcement
should be received positively in the financial
markets. Alternatively, if the financial markets
perceive that the reallocation of corporate
resources from South Africa to other parts of the
world represent a net economic gain, divestment
announcements would again be positive news.
We organize the remainder of this paper into
several sections. In the following section, we
present a literature review which leads to our
hypothesis. Subsequently, we describe our
research methodology, more fully explaining our
process for sample construction and the details
regarding our application of the event method-
ology. Finally, we report our results and provide
a discussion of their interpretation.
LITERATURE REVIEW AND
HYPOTHESIS
Shareholders prefer that senior managers adopt
corporate strategies which enhance firm value.
Senior executives, however, may make decisions

based only upon a comparison of their personal
gains and losses from pursuing a specific strategy
(Gomez-Mejia, Tosi, and Hinkin, 1987; Jensen
and Meckling, 1976; Jensen and Murphy, 1990;
Kroll, Wright, and Theerathorn, 1993; Tosi and
Gomez-Mejia, 1989; Wright et al., 1996).
Personal costs of conducting business in South
Africa for top executives could include the loss
of public image as a humane citizen, lack of
sensitivity to the morally objectionable practice
of apartheid, ongoing political pressures from
members of the community as well as threats of
media exploitation. It is conceivable, then, that
in the context of our study, management may
announce divestment of a South African operation
for personal reasons and in response to various
pressures. This is consistent with Jensen and Mur-
phy’s (1990) contention that private and public
political forces may drive corporate strategy.
In some cases, divestment may be a result of
unprofitable South African business units. In other
cases, the reallocation of corporate resources from
South Africa to other projects might result in a
net gain. Thus, agency conflicts may not be able
to explain divestment decisions in such cases.
The impact of these economically oriented
divestments on stock prices, however, should be
positive as unprofitable units are eliminated or
resources are utilized more efficiently. Note that
we proxy business unit profitability as well as
the efficient utilization of resources via stock
returns because share prices represent expec-
tations of future financial prospects as opposed
to accounting returns which are primarily reflec-
tive of past performance.
Agency problems, however, may well exist in
other situations. We emphasize that, among the
various corporate stakeholder groups, senior man-
agers are the most likely targets for public and
private pressures to divest South African oper-
ations. Other stakeholder groups, such as
employees, suppliers, customers, or shareholders,
are less visible and may be perceived as less
influential in corporate strategy formulation and
implementation. Consequently, these managers
could eliminate such personally costly pressure
by divesting their South African business oper-
ations even though these units may be profitable,
representing the efficient utilization of corporate
endowments. As is evident, the impact of
divestment of profitable units on stock prices
should be negative.
Research Notes and Communications 79
A number of corporations announcing
divestments had good Sullivan ratings, which
imply that their operations were supportive of the
cause of the black South Africans (Lashgari and
Gant, 1989). In this context, then, some of the
divestments may not only have been harmful to
shareholders, but they also may have been soci-
ally irresponsible. The Sullivan ratings of cor-
porations operating in South Africa are traceable
to the Sullivan principles. In 1977, a leading
Philadelphia activist in the antiapartheid move-
ment, the Reverend Leon Sullivan, formulated a
code of conduct for U.S. companies active in
South Africa.
Firms signing this code agreed to an acceptable
minimum wage, equal opportunity for all
employees, integrated work spaces and cafeterias,
equal pay for equal work, training of blacks for
technical and managerial jobs, and to increase
the number of blacks in management (Kaempfer,
Lehman, and Lowenberg, 1987). Note should be
made that in their empirical investigation, Lash-
gari and Gant (1989) have concluded that the
average return on equity for those firms with
good Sullivan ratings has not been diminished by
their subscription to the Sullivan principles.
In retrospect, it can be argued that the continu-
ation of the U.S. government’s recognition of the
South African government as well as the ongoing
operations of many U.S. businesses in that coun-
try were important forces in the reform and in
the termination of apartheid policies of the South
African government (Ford, 1994). Indeed, South
Africa had made such progress in the improve-
ment of its governance that on July 10, 1991
President Bush announced the cessation of all
U.S. economic sanctions against that nation.
Although noneconomic forces, operating both
in the external environment and within organiza-
tions, may be important determinants of corporate
strategy, these forces are not easily subject to
documentation. This is true since such forces
operate in informal and indirect ways. Because
senior managers may have been the targets of
pressures to divest South African operations, they
could selfishly eliminate this personal disutility
by terminating their corporate business interests
in that country even if divestments are costly
to shareholders.
In the context of our discussion to this point,
we anticipate that divestment announcements of
South African business units by corporations may
80 P. Wright and S. P. Ferris
have been motivated by noneconomic forces.
Thus, on average, these announcements may be
associated with a negative market response:
Hypothesis 1: Divestment announcements of
South African operations by corporations are
associated with significant negative abnormal
returns accruing to their common stock.
This hypothesis is empirically tested in our study.
If the empirical results show that divestment
announcements of firms are associated with insig-
nificant returns or with positive excess returns
accruing to stockholders, then we will conclude
that such divestments may not be due to agency
problems. In this situation, our hypothesis must
be rejected. If divestment announcements are
empirically associated with negative excess
returns, however, we may surmise that top man-
agers might have acted on their own selfish inter-
ests which are costly to shareholders. The spe-
cifics of our methodology, which tests the above
hypothesis, are described below.
SAMPLE AND METHODOLOGY
Sample construction
For the period January 1, 1984 through December
31, 1990, a total of 116 divestments are identified
through a search of the list compiled by the
Investor Responsibility Research Center (IRRC)
for corporations departing from South Africa. The
reason for choosing this period of time for study
is that in 1991 all U.S. economic sanctions were
officially ended against South Africa as a result
of that nation’s reforms and the end to apartheid
policies. Thus, the year 1990 is the last full year
during which time private and political pressure
would have been exerted on top managers to
divest South African operations. Also, the IRRC
has maintained this list only since January 1,
1984; hence, data availability restricted our analy-
sis from examining years previous to 1984.
Select firms are excluded from being in the
sample: if the actual event dates of firm
announcements are not available in the Wall
Street Journal or the New York Times indexes
and/or if the firms are not publicly traded compa-
nies. All of the studied divestment announcements
were made by corporations which held a good
Sullivan rating. We utilized the Sullivan rating
as a proxy for whether firms are managed in
response to public expectations (Dutton and
Dukerich, 1991; Solomon and Hansen, 1985).
Divestment of a business in South Africa without
a good Sullivan rating may have been motivated
by concerns for social responsibility as opposed
to having been driven by agency conflict. Conse-
quently, by limiting the sample to divestments of
units with good Sullivan ratings, we attempted
to control for the confounding effect of issue
management (Dutton and Duncan, 1987; Greening
and Gray, 1994).
Moreover, we perused annual reports, searched
the Dow Jones News Retrieval as well as exam-
ined indexes of the Wall Street Journal and the
New York Times to make sure that divestment
announcements studied were not forced on man-
agement by shareholder resolutions. We searched
these data sources also to ensure that divestments
were not in response to lawsuits. Presumably, the
management of corporations which did not face
lawsuits or shareholder resolutions knew that
other firms were confronted with these measures.
It is conceivable, then, that the purpose of their
proactive withdrawal might have been to preempt
being forced out of South Africa.
Nevertheless, in response, an argument may be
made that the firms which proactively divested
may subsequently not have been forced to
retrench. Indeed, even if confronted with share-
holder resolutions or lawsuits, these firms might
have been able to delay—until the sanctions
against South Africa were lifted. Recall that the
ruling white minority government throughout the
middle and latter 1980s had declared that govern-
ment in the 1990s would be determined by free
elections (axiomatically resulting in black
majority rule). Since the period of the study
primarily encompasses the middle to the latter
1980s, it is possible to envision that management
may have had the option to state that they
intended to divest within several years, if apart-
heid policies were not eliminated. The final sam-
ple, compatible with the above criteria, consists
of 31 firm announcements of divestment of South
African subsidiaries. These 31 firms are listed in
Table 1.
Methodology
In order to examine the stock returns surrounding
the announcements of divestments, we apply the

Table 1. List of firms included in sample
Apple Computer Honeywell, Inc.
Bank of Boston IBM
Bundy Corp. ITT Corp.
Chemical Bank Corp. Johnson Controls, Inc.
Citicorp Kodak
Coca Cola McGraw Hill
CPC International, Inc. Merrill Lynch & Co.
Dow Chemical, Inc. Mobil Corp.
Dun & Bradstreet Norton Co.
Emhart Corp. Raychem Corp.
Exxon Corp. Revlon Group, Inc.
Firestone Tire Sara Lee
Fluor Corp. Tambrands, Inc.
General Motors Unisys Corp.
Goodyear Tire Xerox Corp.
Hertz Corp.
event study methodology (Brown and Warner,
1985; Fama et al., 1969). This method analyzes
daily equity rates of return over a period sur-
rounding the specific event of interest. The
observed daily rates of return, available from the
Center for Research in Security prices (CRSP)
data base, are adjusted for the expected rates of
return, calculated according to the Capital Asset
Pricing Model (CAPM) (Sharpe, 1964). By sub-
tracting the expected component of return from
the observed rates of return, we are left with the
excess return which is that portion of return
attributable to firm-specific activity. These excess
returns are then cross-sectionally averaged across
the sample of corporations to obtain a mean
excess return for the particular day in our
reporting window.
In this study, we report the mean unexpected
rate of return for 10 days prior to and 10 days
following the announcement of divestment. The
parameters necessary to calculate the expected
return are estimated utilizing an estimation win-
dow of day 2260 to day 211, which provides
us with approximately a year’s worth of trading
activity. Application of the event study method-
ology focuses on the pattern of daily stock rates
over a period surrounding the event of interest.
This allows one to determine if there is evidence
of information leakage prior to the event or a
lingering effect in the postevent period. Generally,
the impact on shareholder wealth is focused on
the actual event day itself. This is because finan-
cial markets are quick to respond to events that
Research Notes and Communications 81
contain information relevant to a firm’s future
financial performance.
As noted above, the actual daily rates of return
on the firm’s stock are adjusted for the expected
rate of return. The estimation of daily expected
rates of return for a stock is accomplished through
use of the CAPM. The CAPM is an equilibrium
relationship between asset risk and return that
has been widely applied to equity behavior. The
CAPM contends that investors must be compen-
sated by higher rates of expected return in order
to bear additional risk. The event methodology
has been widely used in finance and strategic
management. We should emphasize, however,
that some observers have been critical of the
event methodology and its presumption of market
efficiency (Shleifer and Vishny, 1991).
RESULTS AND DISCUSSION
In Table 2 we present the mean daily common
stock reactions for our sample of firms announc-
ing divestments of South African business units.
On the event day (day 0), there is a significant
and negative excess return of 20.249 percent.
The statistically significant increase in the number
of negative excess returns on the announcement
day indicates that this is a widespread effect
rather than one driven by a few outliers. Our
estimation is supportive of the hypothesis of the
study.
The results of this study suggest that announce-
ments of corporate divestment of South African
business units are associated with significant
negative excess returns. The contribution of our
examination is that it provides some evidence
which suggests that divestments of business units
in South Africa may have been motivated by the
self-interests of senior managers and, as such,
represent the manifestation of an agency problem.
These results are counter to the traditional
theory of the firm where it is assumed that organi-
zations are managed in the best interests of their
owners (Marris, 1964). Moreover, the results are
not supportive of the premise that senior execu-
tives are motivated to act in the best interests of
the shareholders as a result of: capital market
signals (Easterbrook, 1984; Rozeff, 1982), mana-
gerial labor markets (Fama, 1980), and the threat
of hostile takeovers (Manne, 1965; Martin and
McConnell, 1991). Our study provides further
82 P. Wright and S. P. Ferris
Table 2. Excess stock returns surrounding the announcement of the divestiture of business operations

Number of
negative excess Sample Binomial
Daily percentage Cumulative percentage returns size test
Event day excess rates of return t-statistic excess rates of return N(2) N statistic

210 0.103 0.928 0.103 13 31 20.898

29 20.178 20.781 20.075 14 31 20.538
28 0.107 0.377 0.032 14 31 20.538
27 0.099 0.561 0.131 15 31 20.179
26 0.044 0.823 0.175 12 31 21.257
25 20.218 20.340 20.043 14 31 20.538
24 20.112 20.917 20.155 16 31 0.179
23 20.094 20.069 20.249 13 31 20.898
22 20.012 20.093 20.261 13 31 20.898
21 0.142 1.057 20.119 17 31 0.538
0 20.249 22.130* 20.368 23 31 2.694*
1 0.014 0.130 20.354 18 31 0.898
2 0.111 1.122 20.243 13 31 20.898
3 0.172 0.468 20.071 13 31 20.898
4 20.108 20.523 20.179 12 31 21.257
5 20.127 21.047 20.306 14 31 20.538
6 20.144 20.928 20.450 13 31 20.898
7 0.125 1.069 20.325 12 31 21.257
8 20.187 21.081 20.512 15 31 20.179
9 0.130 0.878 20.382 17 31 0.538
10 0.212 1.019 20.170 16 31 0.179
*
p , 0.05.
The binomial test statistic is calculated as: Z 5 [N(2)/N2(0.50)][(N/(.50)2)0.50].

support to the argument of select authors who
claim that managers, as agents of shareholders,
may not always act in the best interests of the
owners (e.g., Gomez-Mejia et al., 1987; Jensen
and Meckling, 1976; Kroll et al., 1993; Tosi and
Gomez-Mejia, 1989).
We also surmise that divestments were not
beneficial to another stakeholder group: the black
citizens of South Africa. This is because corpora-
tions with good Sullivan ratings not only provided
the black South Africans with an appealing work
opportunity, but also they set good examples for
corporate behavior while they served as indirect
or direct forces for antiapartheid reform.
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