Unveiling Synergy Gains in Divestitures Using Options Market Information

Journal: Journal of Business Finance & Accounting

Options markets have been in the news in India recently, mostly because of retail trading and regulatory concerns. But options can also serve a very different purpose: they can help people understand what the market really thinks about major corporate decisions. Unlike stock prices, which only go up or down (and, thus, show whether investors reacted positively or negatively), options market prices provide a richer and more detailed picture about different future scenarios. For example, option prices may suggest that the market is pricing the future as if there is roughly a 60% chance that the stock ends up higher than today’s price and a 40% chance that it ends up lower.

In the paper, the researchers use this idea to study divestitures, where a company sells a division, subsidiary, or asset to another firm. Divestitures are often seen as less glamorous than mergers and acquisitions. M&A deals attract more attention because they are about expansion. Divestitures, in contrast, are often viewed as downsizing or restructuring. The paper shows that this view may be incomplete.

The researchers study 534 US divestiture announcements between 1996 and 2024. Prior research, which mainly relies on stock price reactions around announcements, generally finds that divestitures create limited value. The researchers argue that this approach may miss an important issue. When a divestiture is announced, investors are still uncertain whether the deal will actually be completed. Therefore, the stock price reaction at announcement may understate the value created by divestitures.

By combining information from stock and option prices, the researchers separate the value created by the transaction from other information revealed by the announcement. The findings show that divestitures generate meaningful gains for both buyers and sellers. These gains are large, although part of the positive value is offset by negative new information that the divestiture announcement reveals.

The researchers also show that divestitures can create more value than mergers and acquisitions. Selling a non-core or underperforming asset can help the seller become more focused. Compared to large acquisitions, divestitures may also involve lower integration risk and lower overpayment risk. The central message is simple: sometimes, value is created not by buying more, but by letting go of the right (i.e., underperforming) assets. Divestitures may be an underappreciated strategic tool, and options markets can help uncover their true value.