Portfolio divestment: The cost of doing business in South Africa

Portfolio divestment: The cost of doing business in South Africa

PORTFOLIO DIVESTMENT: THE COST OF DOING BUSINESS IN SOUTH AFRICA Gerald P. Weinstein Pervaiz Alam Laurence E. Blose I. INTRODUCTION Anti-apartheid soc...

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PORTFOLIO DIVESTMENT: THE COST OF DOING BUSINESS IN SOUTH AFRICA Gerald P. Weinstein Pervaiz Alam Laurence E. Blose I. INTRODUCTION Anti-apartheid social activists have called for an international economic boycott against South Africa. In accordance with this effort, the anti-apartheid movement has urged companies doing business in South Africa to discontinue their operations there. In order to bring pressure on the companies that continue to operate in South Africa, the anti-apartheid movement has urged both private and institutional investors to remove from their portfolio those companies with operations in South Africa. As a result of these efforts, numerous medium size and large size investment funds have adopted investment policies with South African restrictions. The size of the investment pool having South African restrictions is substantial. For example, the state pension funds of California, Maine, Massachusetts, Connecticut, Michigan, and New Jersey have South African restrictions. Also, over 100 colleges and universities have divested their holdings of the South African tainted companies. A partial list of those educational institutions includes Boston College, University of California (LA), City University of New York, Columbia University, Michigan State University, Ohio State University, Additionally, several mutual funds have and the University of Wisconsin. adopted a South African free investment policy. Presently, over 100 billion dollars in assets of large and medium size investment funds are restricted from investing in companies doing business in South Africa.1 The advocates of portfolio divestment argue that if enough investors, mutual funds, retirement funds, and other institutional investors refuse to invest in companies with South African operations, then the stock price of those com-

Gerald P. Weinstein Assistant Professor, Department of Accountancy, John Carroll University, University Heights, OH 44118; Pervaiz Alam Assistant Professor, Department of Accounting, Kent State University, Kent, OH 44242; Laurence E. Blose Assistant Professor, Department of Finance and Business Law, University of North Carolina at Charlotte, Charlotte, NC 28223. Global Finance Journal, 2(3/4), 293-307 ISSN: 1044-0283

Copyright o 1991 by JAI Press, Inc. All rights of reproduction in any form reserved.

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panies will be adversely affected. This adverse price effect is a cost that will lower the net present value of South African investments and will provide an incentive for the companies to eliminate those operations. The adverse price effect would arise from a market price adjustment which can be explained as follows: Suppose that all investors are indifferent toward companies doing business in South Africa. If so, then all investors will make their portfolio decisions based only upon the risk (and return) characteristics of the available securities, and each investor will select an optimum portfolio weight for each company. Next, suppose that anti-apartheid investors decide to remove from their portfolios those companies doing business in South Africa. After the portfolio divestment is accomplished, the anti-apartheid investors will have a portfolio weight of zero for those companies and the investors indifferent to the issue will have increased their holding of the companies. In other words, the indifferent investors must hold a greater proportion of the companies doing business in South Africa than they would have preferred prior to the divestment. However, without a change in market prices, the indifferent investors wil1 be unwilling to change from their optimal weights for these securities. Thus, there must be a price adjustment that causes the indifferent investors to choose to hold more of the companies doing business in South Africa.2 This will occur only if there is a decline in the price of the divested securities.3 The extent of a price effect associated with divestiture is of interest to several constituencies. The managers of companies doing business in South Africa would use such information to weigh against the financial benefits of their South African activities when making capital budgeting decisions. If the price penalty is greater than the net present value of the South African activities, then the companies should sell those activities. The results of this study are also of interest to investors and portfolio managers who are considering portfolio divestment. The costs of portfolio divestment can be substantial. For example, Ennis and Parkhill [7] report that the transaction costs of removing South African tainted firms from a $1 billion portfolio would be $15 million.4 Besides transaction costs, there are the costs of managing a portfolio that is prohibited from investing in securities that comprise more than 45% of the securities in the S&P 500.5 These costs include foregone investment opportunities and loss of diversification opportunities. If portfolio divestment has no adverse effect on the price of the divested securities, then portfolio managers should consider the extent to which the costs of divestment are justified by its effects. Finally, the information will be useful to the advocates of portfolio divestment. A finding of either no price effect, or a minimal price effect would indicate that the divestment movement is likely to be a weak tool for affecting corporate behavior.

II. MARKET

REACTION

TO THE SALE OF ASSETS

This study examines the stock price reaction to announcements by firms doing business in South Africa that they are selling or otherwise disposing of their

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South African operations. There have been several studies which have examined the price reaction to announcements by corporations that they are selling or spinning off some of their assets. None of these studies, however, specifically examined the restructuring of South African assets. For example, the sale of assets for cash or other securities was examined by Alexander, Benson, and Kampmeyer [l], Sicherman and Pettway [17], and Tehranian, Travlos and Waegelein [18]. Spin-offs in which new corporations are created and the new stock is distributed to existing shareholders, were investigated by Hite and Owers [12], Miles and Rosenfeld 1151, and Schipper and Smith [16]. All of these studies found significant positive abnormal returns on or around the announcement date. These findings are consistent with the interpretation that asset divestitures are voluntarily undertaken when the divestiture is a positive net present value project. Involuntary divestitures are asset sales that arise from coercion by the government or some other exogenous agent. Kummer [14] and Boudreaux [3] examined involuntary divestitures and found negative returns associated with the divestiture announcements. Overall, these studies are consistent with the interpretation that voluntary divestitures transmit good news to the market while involuntary divestitures transmit bad news,

III. METHODOLOGY If companies doing business in South Africa suffer a price penalty from portfolio divestment, then this penalty will be removed when the firms suspend their South African operations and are no longer subject to the divestment sanction. Accordingly, these securities should experience an increase in price arising from the cessation of business there. In anticipation of this price rise, these securities should show abnormal returns associated with the suspension announcement.6 Using event study methodology, this paper examines the returns around the date of announcements by firms intending to suspend their South African operations. With the assistance of the Investor Responsibility Research Center (IRRC), we identified 161 companies that discontinued their direct investment in activities in South Africa. Of these firms, 116 are publicly traded and are available on the University of Chicago Center for Research in Security Prices (CRSP) daily returns tape (1988 version).7 A questionnaire was sent to each of the 116 firms requesting the date of the first public announcement of their intent to discontinue their South African operations. From the questionnaire, and from an exhaustive search of the WuZZ Street Journal and the files of the IRRC, we determined that the announcement was reported in the press for 68 of the 116 firms. We were also able to obtain the date on which the remaining 48 firms disclosed to IRRC their intent to withdraw from their South African operations. The announcement date for each company was designated as time t = 0 and all other dates were numbered relative to that date. The day designated as t = 0

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was selected depending on how the date was obtained. If the press release was available, then t = 0 was the date of the press release. If there were no press release, or if we could not obtain the press release, then day t = 0 was the day before the announcement appeared in the WuZIStreet Journal. For the dates obtained from the IRRC, the announcement date was the date the announcement was received by the IRRC. Of the three sources of event dates, the IRRC disclosures are the least precise. The market reaction will have occurred prior to day t = 0 for these events if information leaked into the market prior to the announcement to the IRRC. Similarly, if the information did not leak, but if the IRRC disclosure is not an efficient method of reporting information to the market, then the reaction may have occurred after t = 0. For this reason, we report the results for both the entire sample and for the subset that excludes the IRRC announcements. We anticipate that any abnormal returns will be more tightly packed around t = 0 for the press announcement subset then for the entire sample. This suggests that abnormal returns in the press announcement subsample will be more pronounced then those for the larger sample. Using the CRSP value weighted market index, market model excess returns were calculated using the OLS market model described by Brown and Warner [4]. The estimation period used for the market model coefficients was the 150day period beginning 180 days prior to the announcement. Excess returns were estimated for each day during the event period extending from thirty days prior to the event through the thirtieth day after the event.8 Cross-sectional average excess returns (AERJ were calculated for each day in both the event period and the estimation period. The variance of the AER,‘s were calculated during the estimation period and used to obtain the test statistic for each AER, in the event period. The test statistic has a student’s t distribution with 149 degrees of freedom. Cumulative Average Excess Returns (CAR’s) were calculated for various subperiods su~ounding the event date and are also reported. The test for significance of the CAR is T = CAR [tr, t,]/sV?z

(1)

Where CAR[t,,t,] is the CAR over the closed time interval from fl through fs, s is the variance of the AER*‘s, and n is the number of days over which the CAR was calculated (i.e., n = f2 - fI + 1). The null hypothesis is that there will be no abnormal returns associated with the announcement. The alternative hypothesis is that there are positive abnormal returns associated with the announcement. Rejection of the null hypothesis in favor of the alternative hypothesis would indicate that portfolio divestment has had an adverse impact on the price of companies doing business in South Africa. Confounding

Effects

There are at least two possible effects that are likely to be detected using this methodology. The first effect is the capital market price adjustment arising from

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the firm’s removal from the set of companies subject to the portfolio divestment sanction. As explained in the previous section, if the portfolio divestment sanction adversely affects the firm’s price, then an announcement of the disposal of the South African assets will cause an increase in the price of the stock which will be identified as positive abnormal returns in the shares of the announcing firm. The second effect is a capital budgeting effect arising from the change in the net present value of the firm because of the change in the asset structure of the firm. The literature review presented earlier indicates that when firms voluntarily discontinue operations, the decision will be a positive net present value decision and will result in a positive abnormal return. Thus, a finding of positive returns would be consistent with both effects. Accordingly, it may be difficult to separate the effects and identify whether abnormal returns are related to a capital budgeting effect or to a portfolio divestment related market price penalty. This problem of confounding effects is mitigated by the size of the South African assets that are being sold. Klein [13] examined asset sales (not associated with South Africa) and found that the positive abnormal returns are only detected when a firm sells over ten percent of its assets. Smaller asset sales (ten percent or less of total assets) do not have significant abnormal returns, either positive or negative. Hearth and Zaima [ll] also examined the relationship between asset size and abnormal returns. They defined a small divestiture as one in which the liquidated assets are less than eight percent of the total assets of the firm. They found positive abnormal returns in the small divestiture sample, but could not reject them as being significantly greater than zero (at the five percent level of significance). On the other hand, asset sales of relative size in excess of eight percent of total assets had significantly positive returns (at the one percent level of significance). In our sample, all of the asset sales would be classified as small by both Klein’s and Hearth and Zaima’s definitions. Accordingly, we expect that any positive revaluation caused by a capital budgeting effect will be small as well. However, the size of the price effect arising from the portfolio divestment sanction should not be related to the relative size of the firm’s South African assets. Any commerce with South Africa, no matter how small, is sufficient to qualify the firm for the portfolio divestment sanction. Accordingly, because of the expected small capital budgeting effect, if there are significantly positive returns, these returns are likely to be associated with the market valuation effect. On the other hand, absence of a significantly positive effect can be interpreted as absence of a market valuation effect.

IV. RESULTS Table 1 presents average excess returns and cumulative excess returns for selected periods surrounding the announcement date. Two sample groups are reported. The first consists of the complete sample of all 116 firms who announced their intention to discontinue South African operations. The second sample is composed of the 68 firms whose announcement was reported in the press. Neither the complete sample nor the press announcement sample ex-

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hibited significantly positive abnormal returns on the announcement date or on the day immediately preceding or following the announcement date.9 Similarly, none of the CAR’s for either sample are significantly greater than zero. Table 1 reveals an unexpected result. The CAR’s for the 68 firms with press releases are significantly less than zero for the period [-lo, +lO], and for subperiods subsequent to the announcement. A negative CAR associated with the announcement cannot be explained as the divestment price effect described above. These results indicate that the share prices of companies doing business in South Africa actually decline in value when the companies announce that they are discontinuing their South African operations. This effect is the exact opposite of that intended by the organizations prescribing divestment. One possible explanation for this curious result can be found in the research of Kummer [14] and Boudreaux [3] who found that companies that are forced to sell off a portion of their business suffer a price decline associated with the announcement of the forced sale. Although the decision to sell South African assets in response to public and political pressure is not a forced sale, there is some similarity to the conditions studied by Kummer and Boudreaux. In both cases the asset sale is made for other than pure capital budgeting reasons. If the decision to discontinue operations in South Africa was made in response to political, social, or some other pressure, rather than as a pure capital budgeting decision, then discontinuance of operations is likely to have a negative net present value. The negative NPV would result from the loss of prospective future positive net cashflows from the South African activities. This interpretation is consistent with the finding of a negative return during the event period in the subset of firms with press reports. Table 2 presents a tabulation of the number of companies with positive excess returns and the number of companies with negative excess returns on each day during the three day period from t = -1 through t = 1. A Wilcoxon Signed Rank Test was performed on the individual statistics and is also reported in Table 2. This test indicates that for the entire sample, the number of positive excess returns during that period are not significantly greater (or less) than the number of negative returns.

Residual Ties Of the 116 firms in the sample, 65 of the firms retained some association with the South African operations after the assets were sold. These nonequity ties in most cases consisted of either a licensing or a trademark agreement with the severed organization. In order to test how the presence of these nonequity interests diluted our results, we partitioned the sample into two subsamples composed of the 65 companies with nonequity ties in one subset, and 39 firms that severed all ties in the other (we could not classify 12 of the 116 as firms being in one or the other subset). We then examined each subset for the presence of abnormal returns. The first column in Table 3 indicates that there is no evidence of a significantly

Table 1 ABNORMAL RETURNS ASSOCIATED WITH ANNOUNCEMENT OF INTENTION TO CEASE SOUTH AFRICAN OPERATIONS Panel A: Daily Abnormal Date Relative to Announcement t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t=

-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10

Panel B: Cumulative

Days in Interval -30 to -10 to -5to -lto oto -1 to oto -5 to 0 to -10 to 0 to -30 to

0 0 0 0 +1 +1 +5 +5 +10 +10 +30 +30

Returns Complete Sample (All 116 Firms) -0.0022 -0.0004 -0.0008 0.0031 -0.0006 0.0016 0.0018 -0.0001 -0.0004 -0.0001 -0.0002 0.0018 -0.0002 -0.0010 0.0025 -0.0035 -0.0018 -0.0020 -0.0016 0.0014 -0.0054

Daily Abnormal

(-1.11) (-0.21) (-0.37) (1.52) (-0.27) (0.76) (0.87) (-0.06) (-0.21) (-0.03) (-0.09) (0.88) (-0.10) (-0.49) (1.23) (-1.71) (-0.88) (-0.97) (-0.76) (0.68) (-2.62)*”

-0.0025 0.0002 -0.0021 0.0056 -0.0031 0.0028 0.0045 -0.0022 -0.0033 -0.0008 0.0006 0.0005 0.0008 -0.0026 0.0032 -0.0055 -0.0050 -0.0037 -0.0032 0.0013 -0.0069

(-1.07) (0.08) (-0.92) (2.44)* (-1.33) (1.23) (1.97) (-0.98) (-1.46) (-0.35) (0.26) (0.24) (0.33) (-1.11) (1.41) (-2.41)+ (-2.18)* (-1.62) (-1.39) (0.54) (-3.00)=+

Returns for Selected Periods.

Complete Sample (All 116 Firms) 0.0179 0.0016 0.0026 -0.0003 0.0016 0.0016 -0.0006 0.0022 -0.0099 -0.0081 -0.0171 0.0010

68 Firms with Press Reports

(1.59) (0.25) (0.56) (-0.12) (0.79) (0.54) (-0.13) (0.33) (-1.53) (-0.88) (-1.52) (0.06)

Notes *Significant at the 5% level, two tailed test **Significant at the 1% level, two tailed test

68 Firms with Press Reports 0.0049 -0.0003 0.0016 -0.0002 0.0012 0.0003 -0.0029 -0.0020 -0.0205 -0.0214 -0.0429 -0.0386

(0.39) (-0.04) (0.30) (-0.09) (0.50) (0.11) (-0.57) (-0.27) (-2.82)+* (-2.08)* (-3.41)** (--2.17)*

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Table 2 NUMBER OF POSITIVE AND NEGATIVE EXCESS RETURNS DURING THE PERIOD FROM t = -1 THROUGH t = +l Event Relative Date No. of Pos. Abnormal

t = -1 Returns

No. of Neg. Abnormal Returns Total Count Significant Returns* Positive Negative Wilcoxon Signed Rank Test Score** Positive Negative

t=o

t = +1

CAAR [-1,

52

59

61

61

64 116

57 116

55 116

55 116

3 3

4 1

7 4

3 2

3250 3536

3342 3444

3682 3104

3459.5 3325.5

+l]

*The number of excess returns positively and negatively significant at the 5% level (two sided test). **A Wilcoxon score smaller than 2682 is necessary for significance at the 5% level. Thus, results of the test are not significant either positive or negative.

positive return associated with the event for the 65 firms which retained a nonequity tie to the severed organization. This subset would be less likely to exhibit an increase in price because of the retention of nonequity ties. The second column in Table 3 reports the results for the 39 firms which severed all ties when they discontinued their South African operations. These companies had significantly positive abnormal returns on the day t = -4 and t = -3; furthermore, the CAR for the closed interval [t = -5, t = 0] was significantly positive as well. These abnormal returns, although significant, are quite weak. The day f = -4, and f = -3 abnormal returns represent a price change of only .5% for each day. They are barely significant at the 5% level (two-sided test). Furthermore, the significantly positive abnormal returns are short lived. When the window for the CAR is widened to [t = -5, t = +5] the CAR is no longer significant and when it is widened further still to [t = -10, t = +lO], the CAR turns negative. The CAR for the entire event period [t = -30, t = +30] is negative as well. As mentioned earlier, there were 68 companies that had press announcements regarding their withdrawal from South Africa. Of these, 42 companies retained a nonequity interest, 23 companies did not retain a nonequity interest, and three of the companies could not be classified with regard to nonequity interest. Since the announcement dates for the press announcements are more precise then the dates for the IRRC disclosure, the press announcement sample was sub-divided depending upon whether or not the companies kept a nonequity interest. The subsamples were tested separately and the results are presented in Table 4.

Table 3 ABNORMAL RETURNS FOR COMPANIES THAT DID AND DID NOT RETAIN NON-EQUIP I~EREST Panel A: Daily Abnormal

Date Relative to Announcement t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t= t=

-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10

Panel B: Cumulative

Date Relative to Announcement -30 to -10 to -5to -lto oto -lto oto -5 to 0 to -10 to 0 to -30 to

0 0 0 0 +1 +1 1-5 +5 +10 “i-10 1-30 +30

Returns 65 Companies Retaining NonEquity Interest -0.0024 -0.0005 -0.0001 0.0029 -0.0017 -0.0009 0.0034 -0.0022 -0.0012 0.0013 -0.0021 0.0011 0.0011 -0.0031 0.0044 -0.0027 -0.0030 -0.0053 -0.0014 0.0026 -0.0037

Daily Abnormal

(-0.93) (-0.19) (-0.03) (1.13) (-0.66) (-0.34) (1.30) (-0.85) (-0.47) (0.49) (-0.81) (0.41) (0.42) (-1.21) (1.69) (-1.06) (-1.17) (-2.05)’ (-0.52) (1.01) (-1.43)

-0.0053 -0.0007 -0.0020 0.0039 -0.0000 0.0047 0.0053 0.0051 -0.0029 -0.0008 -0.0005 -0.0010 -0.0040 0.0016 0.0025 -0.0060 -0.0015 -0.0019 -0.0007 0.0014 -0.0049

(-2.19)* (-0.31) (-0.83) (1.59) (-0.00~ (1.93) (2.19)* (2.09)* (-1.20) (-0.31) (-0.19) (-0.40) (-1.66) (0.66) (0.61) (-2.46)* (-0.63) (-0.77) (-0.30) (0.56) (-LOO)+

Returns for Selected Periods.

65 Companies Retaining NonEquity Interest 0.0075 -0.0035 -0.0018 -0.0008 -0.0010 0.0002 -0.0014 -0.0011 -0.0122 -0.0137 -0.0178 -0.0082

39 Companies Not Retaining NonEquity Interest

(0.53) (-0.43) (-0.31) (-0.32) (-0.40) (0.06) (-0.25) (-0.56) (-1.49) (-1.18) (-1.26) (-0.41)

*Significant at the 5% level, two tailed test *“Significant at the 1% level, two tailed test

39 Companies Not Retaining NonEquity Interest 0.0028 0.0068 0.0110 -0.0012 -0.0015 -0.0022 -0.0084 0.0031 -0.0160 -0.0088 -0.0230 -0.0198

(0.21) (0.88) (2.02)* (-0.50) (-0.60) (-0.64) (-1.54) (0.40) (-2.08)* (-0.81) (-1.70) (-1.05)

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Table 4 ABNORMAL RETURNS FOR COMPANIES WITH PRESS ANNOUNCEMENTS THAT DID AND DID NOT RETAIN NON-EQUITY INTEREST Panel A: Daily Abnormal

Date Relative to Announcement t = -10 t= -9 t= -8 t= -7 t= -6 t= -5 t= -4 t= -3 t= -2 t= -1 t= 0 I= 1 t= 2 t= 3 t= 4 t= 5 t= 6 t= 7 t= 8 t= 9 t= 10

Returns1 42 Companies Retaining Non-Equity Interest -0.0006 -0.0010 0.0004 0.0034 -0.0025 0.0005 0.0054 -0.0027 -0.0012 0.0001 -0.0016 0.0007 0.0012 -0.0060 0.0066 -0.0042 -0.0066 -0.0030 -0.0040 0.0023 -0.0086

(-0.20) (-0.30) (0.11) (1.08) (-0.80) (0.16) (1.73) (-0.86) (-0.39) (0.02) (-0.50) (0.21) (0.37) (-1.94) (2.11)* (-1.33) (-2.13)* (-0.95) (-1.29) (0.74) (-2.76)*”

23 Companies Not Retaining NonEquity Interest -0.0067 0.0013 -0.0052 0.0082 -0.0032 0.0075 0.0042 -0.0012 -0.0056 -0.0030 0.0016 0.0001 -0.0009 0.0039 -0.0016 -0.0087 -0.0041 -0.0055 -0.0020 -0.0004 -0.0061

(-1.97) (0.39) (-1.55) (2.42)” (-0.95) (2.22)* (1.25) (-0.34) (-1.67) (-0.89) (0.48) (0.03) (-0.25) (1.15) (-0.47) (-2.56)* (-1.21) (-1.63) (-0.59) (-0.12) (-1.80)

As in the previous tests, there are no abnormal returns during the event day or on the previous day or the day after. For the subsample of 23 companies severing all ties, there are positive abnormal returns on days t = -5 and t = -7. However, the abnormal returns are weak (less then 1%) and occur several days prior to the event period. Furthermore, the CAR from t = -10 to t = 0 is negative. The tests presented in column 2 of Tables 3 and 4 indicate that there was at most, a weak positive price adjustment within a few days prior to the announcements that the firms are unconditionally discontinuing their South African activities. This weak positive price adjustment was not detected in the subsamples of companies that retained nonequity interests in South Africa. The positive returns during this period are consistent with a market price penalty associated

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Table 4 continued Panel B: Cumulative

Date Relative to Announcement -30 to -10 to -5to -lto oto -1 to oto -5 to 0 to -10 to 0 to -30 to

0 0 0 0 +1 +1 +5 +5 +10 +10 +30 +30

Daily Abnormal

Returns for Selected

42 Firms Retaining Non-Equity Interest 0.0035 0.0001 0.0005 -0.0015 -0.0009 -0.0008 -0.0034 -0.0013 -0.0233 -0.0216 -0.0536 -0.0485

(0.21) (0.01) (0.06) (-0.48) (-0.29) (-0.19) (-0.48) (-0.13) (-2.36)” (-1.55) (-3.13)** (-2.01)$

Notes i0f the 68 firms with press reports, 42 retained non-equity retain non-equity interest, and 3 could not be classified. *Significant at the 5% level, two tailed test **Significant at the 1% level, two tailed test

Periods. 23 Firms Not Retaining NonEquity Interest -0.0017 -0.0020 0.0035 -0.0014 0.0017 -0.0013 -0.0055 -0.0036 -0.0236 -0.0273 -0.0273 -0.0406 interest,

(-0.63) (-0.20) (0.47) (-0.42) (0.51) (-0.27) (-0.73) (-0.33) (-2.20)* (-1.80) (-1.47) (-1.55) 23 did not

with doing business in South Africa. However, all of the subsamples in Tables 3 and 4 had significantly negative returns during the lo-day period following the announcements.

V. SUMMARY

AND CONCLUSIONS

This paper examined the price response to companies announcing that they are discontinuing their activities in South Africa. The complete portfolio of 116 firms in the sample did not exhibit significant positive excess returns associated with the announcements. We also examined a subset of 39 firms which severed all ties (including nonequity ties) with their South African affiliates. This subsample exhibited a weak but significantly positive return. For the subset, the cumulative excess abnormal return (CAR) over the 6-day period ending with the day of the announcement represents only a 1.1% increase in the average price of the securities in the sample. This CAR was barely significant at the 5% level (two-sided test). Furthermore, when the CAR is calculated over wider periods such as from 5 days prior to the announcement to 5 days subsequent to the announcement, the CAR is no longer significantly different from zero. Accord-

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ingly, we conclude that there is at most a very weak market price penalty for doing business in South Africa. This study also found significantly negative returns during the period following the announcement for the 68 firms with press releases. The negative returns can be explained as the market reaction to a decision that was made for political or social rather than capital budgeting reasons. Such a decision is likely to have a negative net present value. If so, then the announcement will precipitate a price adjustment which would account for the negative return. The evidence presented in this paper indicates that any market price penalty is weak if it exists at all. Thus, firms doing business in South Africa and whose goal is to maximize the wealth of the shareholders, should focus their attention on the capital budgeting effects (i.e., the net present value) of the decision whether or not to continue those operations. Additionally, portfolio managers and investors should recognize that divestment of the South African companies has a minimal adverse effect on the price of the divested securities. Therefore, divestment is likely to bring little if any incentive to the management of firms to change their involvement in South Africa. Since, as described above, the cost of portfolio divestment can be substantial, it is likely that the cost exceeds any benefits to be obtained from following a divestment policy. The results reported in this paper have implications beyond the South African problem. It is not uncommon for special interest groups to attempt to affect a target company’s behavior by urging portfolio divestment by investors. Divestment has been used at various times against such diverse companies as tobacco and liquor companies; petroleum, mining and natural resource companies; defense contractors; and companies experiencing labor problems. However, very few if any of these divestment movements have had the scope or the magnitude of participation enjoyed by the South African divestiture movement. The results of this research indicate that portfolio divestiture is likely to be a weak tool for affecting corporate behavior.

ACKNOWLEDGMENTS We would like to thank the Investor Responsibility Research Center in Washington DC for their assistance in identifying those companies that have eliminated their South African operations and for providing substantial background information for the study.

NOTES 1. Information regarding the size of the South African restricted investment pool was obtained from Domini and Kinder [6], Coons [5] and from the Investor Responsibility Research Center Inc., Washington, DC.

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2. A similar argument describing how the price equilibrium can be disrupted by the South African divestment movement is made by Grossman and Sharpe [9]. Additionally, several researchers have shown how other various market frictions can create a segmented market in which equilibrium prices deviates from the prices that would be achieved in the frictionless market underlying the Capital Asset Pricing Model (CAPM). For example Black [2] shows that tax barriers to international investment can cause prices to deviate from those predicted from the international CAPM. Also, Eun and Janakiramanan [B] shows that equilibrium prices will segment when domestic investors are constrained to hold only a portion of foreign firms. 3. The size of the decline will depend upon how many shares are divested, and the extent to which the companies doing business in South Africa have similar risk characteristics to those which are not in South Africa (i.e., the extent to which the companies are substitutes). 4. Grossman and Sharpe [9] also examine the transaction cost of portfolio divestment. They discuss estimates that range as high as $25 million for a $1 billion portfolio. They argue that there are economies that can be enjoyed in a program of portfolio divestiture that have not been adequately modeled in these estimates. After making appropriate adjustments, they argue that the cost of portfolio divestiture would be about $5 million for a $1 billion portfolio. 5. Asset value as of December 1983 as reported by Grossman and Sharpe [9]. 6. It is important to note that the abnormal return will be observed at the time of the announcement that the firm intends to cease South African activities. The ethical investors will not be interested in holding the stock until after the divestiture actually occurs. However, investors indifferent to the firm’s South African policies will purchase the stock in anticipation of the increased demand from the ethical investors (and the resulting higher price). 7. With the help of the Investor Responsibility Research Center we were able to profile the manner in which the companies in our sample withdrew from South Africa. Of the 116 firms in the sample, 68 (58.6%) sold their assets to South African interests, 3 (2.6%) sold their assets to U.S. Interests, and 18 (15.5%) sold their assets to non-South African or U.S. interests. Nineteen (16.4%) of the firms simply closed or terminated their operations. We could not determine the method of withdrawal for the remaining 8 (6.9%) of the companies. None of the 116 firms retained any equity interest in the South African operations; however, 65 retained some nonequity ties (such as licensing agreements) to those operations. These 65 companies are treated as a separate subset in the methodology section. 8. The test was also run using an estimation period that straddles the event period running from t = -250 through t = +250 with the event period t = -30 through t = +30 removed. The results were similar to those reported in Table 1. Using the longer estimation period did not change our results. 9. Unless otherwise indicated, significance indicates rejection of the null hypothesis at a level of significance of 5% or less using a two-tailed test.

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[17] Sicherman, Neil W., and Richard H. Pettway, “Acquisition of Divested Assets and Shareholders’ Wealth,” @unaZ of Finance, 42:1261-1273 (December 1987). [18] Tehranian, H., Nickolaos G. Travlos, and J, Waegelein, “The Effect of LongTerm Performance Plans on Corporate Selloff-Induced Abnormal Returns,” Journal of Finance, 42:933-942 (September 1987).