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Paper Type: Free Essay Subject: Business
Wordcount: 2714 words Published: 1st Jan 2015

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To date, very few studies have taken a look at what might influence whether foreign subsidiaries are divested or not. Most of the literature looks into the reason why MNEs disinvest and the different factors which need to be considered when divesting in a region. More recent studies deal with a firms decision to relocate and the different strategies of a company in its divestment decision.

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Defination of divestment

Torneden (1975) defined divestment as a MNC s decrease in its ownership percentage of a controlled and active foreign operation. Hood and Young (1979) went on to further define it as undoubtedly a politically sensitive issue for the foreign investor. A MNE s decision for divestment usually occurs fin the context of the relationship with host countries, and especially so in developing countries. Hood and Young (1979) went on to find that the major factors of divestment are ownership changes, expropriation, nationalization, sales of assets, liquidation and domestic economic recession. When MNE disinvestments occur in developing countries, the effect will be unemployment, a short-term financial shortage, and the cost for reconstructing relationships with the host countries. From their study they established that divestment occurs when the returns from other new opportunities are in excess of those from exiting projects in the current host economies.

Rationale behind divestment

What is very important when looking into why these companies divest is analyzing the causes or motives for the disinvestments to take place. Van Den Bulke(1979) revealed a few main considerations that need to be looked at as to the reasons why companies disinvest. They are: financial, poor investment analysis, adverse environmental conditions, lack of resources and external pressures.

Financial Considerations as defined by Van Den Bulke(1979) is the poor performance of the subsidiary or division after a suitable period, and with no anticipated improvement; inability of the parent company to sustain further losses ;or lack of capital to finance the modernization or expansion necessary to survive. This definition was backed up by the work of Toreden who found that sixty percent of the companies he studied listed an unacceptable return on investment as the predominate explanation for disinvestments Torenden(1975). Sachdev(1976) also observed that poor performance at the outset of an investment is generally accepted and that and irretrievable disaster does not necessarily lead to a divestment in trying to maintain the skeleton firm can be a face saving gesture or the result of pressure form government and unions who are equally at a loss about how to salvage the operation.(269-271Sachev).However Van den Bulke(1979) points out that other factors and processes important to and poor financial situation is a necessary but not a sufficient condition to generate divestment.

Poor pre-Investment Analysis – indicates that investment or acquisition s were made without the benefit of a careful preliminary analysis.. A study by Business International (1976)l found the thirty four percent of companies mentioning bad acquisition s as a key divestment factor. While Kitching (1973) used data from a sample of US Acquisitions in Europe and found that at least twenty five per cent of the acquisition s where judged to be failure s due to the lack of sufficient consideration of environment and corporate factors. Torneden(1975) emphasized that the premature and immature enthusiasm of the parent s company s top executives for foreign investment that ended badly were later acknowledge to have been poor decision s in the first place.

Adverse Environmental Conditions – Van den Bulke(1979)notes that risk and opportunities shift from country to country and worldwide and regional developments become apparent such as soaring energy costs, rising nationalist feeling s and government controls, leftist advances and growing worker participation in decision making. Torenden(1975) noted in reference to the Latin American countries he studied that the companies which were less committed or disillusioned about international operations following some divestments in relation to there international operations.

Lack of “Fit” people and resources – Sachdev(1976) noted in the cases he studied that a few of the firms withdrawing from foreign operations where doing so because of better prospects elsewhere and Sachdev(1976) labeled this as a “offensive “ divestment strategy as compared to divesting for defensive of reasons or on a planned basis as in the fade out formula imposed by a number of less developed countries. Franko (1971) also linked divestment to the normal pruning and rationalization that takes place in companies as they age and shift their production bases in the light of changing economic conditions around the world.

Organanisation and Industrial Structure.- Torenden(1975) found that there were twice as many divestment among product based organisations as in geographically orientated ones. While in a study done on a larger scale Sachdev(1976) found that the propensity to divest is also higher in fully integrated operations which are more visible in the host country; in the firms with market dominance ,which are more vulnerable politically; and in those that are fully owned and want to retain control, or will get out of it if they cannot Sachdev(1976).

External Initiating pressures.- Sachdev(1976) detailed many cases where government involvement has hindered the development of the company in the form of refusal to grant permission to expand, modernize and increase prices as well as pressures regarding the use and training of local nationals, and the development of exports and local technology led to voluntary or semi voluntary divestment.

Research conducted by Hamilton and Chow (1993) from a survey covering the period 1985-1990, showed that divested companies are larger and faster growing than non divesting firms, finding that the major motivation for divestment was optimum allocation of capital for new opportunities from unattractive assets.. Dunning (1998) explained that divestment occurs primarily when competitive advantages, such as technologies, are weak compared to local firms in host countries. Kim & Shin (1995) put more emphasis on the operating years in the host country. Age of investment is found to be an important classification determent for disinvestments this view support Dunning (1988) viewpoint of divestment the older the divestment period, the weaker the competitive advantage s, such as technology.

Porter(1986) held that divestment might be expected to be more common in firms with a strategy of high FDI and strong coordination among subsidiaries than those in a multi-domestic strategy. Likewise Parahalad and Doz, (1987) concluded divestment propensity would be higher in firms with a world product strategy than in those with a local responsiveness strategy. In the host country Torneden(1975) pointed out that a foreign disinvestments can create a general uneasiness concerning possibilities of increased unemployment and decreased exports. Torneden(1975) also highlights that the host countries desire for more foreign investment is accompanied with a fear that disinvestments s would act to the detriment of potential and present U.S investors. For example Torneden(1975) studied a Belgium brewery company that disinvested in Belgium and found that the divestment caused an aggravation of employment problems in a depressed area as well as financial losses in Belgian banks.

Hirchmen in How to Divest in Latin America and Why (1969) emphasized the importance of political rather than economic factors in the transfer of U.S resources to foreign countries. He also argued that foreign direct investment may actually stunt economic development abroad and consequently hinder relationships between the U.S and the host countries.

Disinvestment decisions could also be a consequence of purely internal considerations. For example to free capital and management resources for more profitable activates or new technological ventures. Van den Bulke(1979)

In the results of Torneden(1975) study on foreign disinvestments by American companies he found that only 4 out of 34 responding companies indicated that they had contacted host government officials prior to making the disinvestments plans and although a large percentage of companies indicated that it was very likely that they would invest again in the same country in the near future

Streams of divestment

Chow and Hamilton (1993) identify three main streams of divestment; industrial organization, finance, and corporate strategy.

Financial- the focus on this is the impact of divestment on company performance. A small amount of studies have looked at profitability measures e.g. Haynes, Thompson and Wright(2002), Modern evidence Markides(1995) suggests that divestments usually increase the market value of a company and not just for domestic divestiture but also have an impact on foreign owned companies as was shown in Padmanabhan(1993). Different suggestions have been made as to the cause of disinvestments. Markides, (1995) highlights that misguided acquisition policies and corporate diversification strategies appear to be particularly likely to foster divestiture as time passes.

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Industrial Organization- the literature by Siegfried and Evans (1994) on industrial organization was mainly concerned with incentives to exit as well as impediments to exit. They found that the most apparent incentive to exit is low profits, which in turn are due to high cost; permanent decreases in demand, or entry into an industry by aggressive, more efficient new competitors. However other literature Haynes, Thompson and Wright (2003) propose that divestment depends on diversification while Caves and Porter (1976) argue that owners of independent plants have a lower opportunity cost and are therefore willing to accepts lower rate of return than operation belong to a multi-plant/multi-industry company would expect to achieve.

Corporate strategy perspectives- Hamilton and Chow (1993) found in their study of over 208 divestments made by large New Zealand companies during the eighties that the necessity of meeting corporate liquidity requirements were among the most important objectives motivating divestment. Also several interview based studies found that lower dependency between units and the need to focus on core activates strongly motivate the decision to divest. Hamilton and Chow(1993).

Bartlett and Ghoshal (1989), argued that divestment propensities of foreign subsidiaries depend on the type of strategy pursued by the corporation. Subsidiaries of transnational corporations are in general likely to display the highest divestment rates. Whereas subsidiaries forming part of international and multi domestic strategies may have the lowest divestment likelihood initially, subsidiaries established as part of global strategy are expected to be least probable to be divested in the longer run. Penning and Sleuwaegen(2000) looked at divestment from the viewpoint of relocation of manufacturing capacity as a response to the increasing cost disadvantages of advanced economies like Belgium where Roberts and Thompson (2003) studied the effects of political and institutional transformation in transition economies such as Poland. In contrasting studies from Barkema, Bell and Pennings (1996), Shaver,Mitchell and Yeung(1997) focused on the relationship between cultural and experimental aspects of foreign expansion and divestitures. The results of Li (1995) and Benito (1997) studies also provided an indication that international diversification entails a higher risk of subsequent exit than foreign ventures within the parent company’s main line of business.

Perspectives of disinvestment

Benito (2003) argued that divestments could be envisaged form a four-fold perspective, as they may be the results of firm adjustments, of failures, of re-structuring or of external impositions. He also argued that subsidiaries of MNE following global strategies are, in the medium to long term are less prone to divestment. However contrasting studies by (Fennstra and Hanson 1996) and (Markusen 2002) held that outward investments can raise the demand and wages for skilled labor in both the parent and host country. Penning and Sleuwaegen,(2006 ) tested two hypothesis using data from there 200 study of Belgium 1. If a smaller firm relocates to a nearby location whereas larger firms move to a more remote location. 2.Wheter public aid distorts relocation decisions. They found that wages and market potential in a host region are important determinants for location choice and also that; larger firms have a higher propensity to relocate to remote countries, while public aid seems to affect only decisions of firms moving to an adjacent region.

Pike (2003) created a perspective of divestment as a process he found three situations which may be inter related.

1.Corresponding to an increasing “anaemai” of the subsidiary, with the reduction of its manufacturing activity and employment.

2. Technological downgrading, when the subsidiary is losing ground in the manufacturing of new generations of more technology intensive products, thereby becoming focused on low skill incentive or mature products.

3.Relevence decline, envisaged as a “slimming” of the subsidiary as a consequence of changes in MNE subsidiaries to supply local markets and/or to allocate international production Benito, (2003) while the work of O Grady and Lane (1996) and Fenwick, Edwards and Buckley,(2003) found the effect of cultural distance increases the probability of divestment, while intuitive and common sense expectation that subsidiaries human capital is a strong deterrent of divestment.(Mata and Portugal (2000).

Brouwer et al (2004) highlighted that from a theoretical perspective the relocation process can be analyzed in terms of neoclassical, behavioral and institutional theories. From the perspective of the neoclassical theory the driving force behind this theory is that firms location choice is related to maximizing profits. the detrainments of a firm relocation usually involve the characteristics of the host country relative to those of the home country in relation to market size, wage levels, workers education etc.

The institutional theory says that firm location is an outcome of a firms investment strategy and as a result is clearly influenced by external factors such as the growth in economic activity, the level of state intervention or any involvement in a merger, takeover or other similar situation The behavioral location theory looks in to the internal factors which influence the decision making process of a firm considering relocation. i.e. factors such as firm age and size. This study found different results than the study by Van Dijk finding that economic environment of firms does affect their mobility decisions in articulating a change in the firms demand effects their decision to relocate.


Throughout the literature regarding divestment the main themes dealt with are the rationale behind why divestment takes place such as the different considerations that take place as highlighted by Van den Bulke(1979). Previous littuire also looks at the different perspectives of divestment Pike (2003) and the different streams of divestment Chow and Hamilton (1993).

However the literature remains scarce regarding the different perspectives regarding the rationale behind divestment for a social capital perceptive. Nowhere in the literature details the viewpoints of people effected my divestment as to it causes, its rationale or its knock on effects. This is an area in which the researcher regards as significant since the people who have been effected by divestment or who have worked closely with divested firms will have a significant viewpoint and perspective regarding divestment.


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