Divestment Options: The Choice between Firm and Asset Sale

This paper develops and tests a theory of optimal divestment policy of an investor in a firm that may gradually divest its assets or sell the whole firm at once. The model builds on the price-flexibility trade-off between the two divestment options. Asset divestitures offer greater flexibility but at discounted prices while a whole-firm sale provides a price premium but with little flexibility. The model predicts that firm sale is preferable over asset divestiture in smaller firms, with higher profit volatility, in more declining markets, and if capital is less industry-specific. We find strong empirical support for the predictions of our theory.