Conventional research on raising capital focuses on the two usual suspects that inhabit balance sheets: equity and debt. But as authors Alex Edmans and William Mann remind readers in a recent Wharton research paper, selling non-core assets also fills corporate coffers with cash.
Financing Through Asset Sales probes the choice to issue equity or sell non-core assets such as a division or a plant. As a means of raising cash, under what conditions are asset sales or equity issues likely to add more value? Edmans, a Wharton finance professor and a faculty research fellow at the National Bureau of Economic Research, and Mann, a Wharton PhD candidate, have an answer.
They propose three forces behind decisions to sell equity or sell non-core assets, which they call the camouflage, correlation and certainty effects. These three effects pierce a veil that up to now has concealed underlying causes of corporate strategy and market reactions. Resulting insights, they say, furnish managers with a better framework for reaching decisions about the amount and purpose of financing, pivotal factors in the long-term viability of any business large or small.
Edmans developed a hunch about the camouflage and correlation effects while working in investment banking in London for Morgan Stanley, before he received his PhD from MIT. “In 2001 to 2003, firms were raising financing through asset sales when it was difficult to raise equity,” Edmans notes. “I saw asset sales being commonly used in the real world, but when I entered academia, I realized that most papers on capital-raising focused on debt and equity issuance.”
Data supported a deep dive into non-core asset sales as a means of raising cash. In 2010, asset sales that raised $133 billion outpaced seasoned equity issuance in the US by $3 billion, according to the Securities Data Corporation. Unique as the economic climate might have been at that time, the ratio of asset sales to equity issuance by corporations was consistent with previous years.
In view of a nearly 1-to-1 ratio of asset sales to equity issuance, one might wonder why researchers took so long to notice. Edmans suggests that asset sales failed to lure attention chiefly because experts anticipated an obvious explanation – firms sell assets if they are easy for outsiders to value. In the academic world, Edmans says, expectation of obvious results dampens motives for research, since there is no need to write a paper if one can already guess the conclusion based on common sense.
The existing research on asset sales is largely empirical, he notes. One paper investigates alternative uses of proceeds. Several others look at the market reaction to asset sales. The few theoretical papers out there treat asset sales as the sole source of financing. None evaluate, from a theoretical standpoint, the comparative merits of non-core asset sales versus equity issuance – ie, under what conditions should a firm raise equity, and under what conditions should a firm sell assets. This is what Edmans and Mann set out to do.
