Strategic Management Journal

Strat. Mgmt. J., 26: 321–331 (2005) Published online in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/smj.449

THE VALUE FROM ACQUIRING AND DIVESTING A JOINT VENTURE: A REAL OPTIONS APPROACH
M. V. SHYAM KUMAR*
Baruch College, The City University of New York, New York, U.S.A

This study examines the value created from acquiring and divesting a joint venture. Unlike previous research which focuses on parent firm factors, the study examines value in light of the reason behind the termination of the venture and the characteristics of the target market. Consistent with the real options view, the paper finds that ventures divested to refocus a parent firm’s product market portfolio were associated with significant value creation. In contrast, ventures acquired with the objective of growth and expansion in a target market, while not associated with significant value creation, did not destroy value either. Apart from these results, the paper also finds that acquirers and divesters gained lesser value when they terminated ventures in uncertain and concentrated industries. These latter findings highlight an important caveat with regard to termination: joint ventures confer valuable flexibility which is also forgone once they are terminated. Implications are discussed. Copyright  2005 John Wiley & Sons, Ltd.

INTRODUCTION
The dynamics of inter-firm collaboration and joint ventures are increasingly capturing the interest of researchers in strategy and international management. This interest partly stems from the fact that while joint ventures continue to proliferate the corporate landscape, they have also been known to exhibit termination rates of 50 percent or higher in various samples (Harrigan, 1988; Kogut, 1989; Park and Russo, 1996; Porter, 1987). One particularly important feature of joint ventures that has been extensively studied in the literature is that often they terminate in an acquisition by
Keywords: joint ventures; real options; termination; event study; acquisitions; divestitures

*Correspondence to: M. V. Shyam Kumar, Baruch College, The City University of New York, Department of Management, Box B9-240, One Bernard Baruch Way, New York, NY 10010, U.S.A. E-mail: Shyam Kumar@Baruch.cuny.edu

one of the partners. Several studies have documented that terminating a joint venture through an acquisition is a fairly widespread phenomenon (Gomes-Casseres, 1987; Bleeke and Ernst, 1995; Hennart, Kim, and Zeng, 1998; Dussauge, Garette, and Mitchell. 2000). However, while these studies have provided valuable insights, they do not examine the impact of acquiring a venture (or correspondingly divesting a venture) on the performance of a parent firm. The issue is of interest to researchers since it offers the potential for understanding the conditions under which acquiring/divesting a venture would enhance the value of a parent firm. Recently some studies have taken an important step in this direction by assessing stock price reactions to joint venture termination announcements (e.g., Reuer and Miller, 1997; Reuer, 2000, 2001). But these studies chiefly relate stock price reactions to various firm-specific factors, such as the level of technical and marketing assets, rather

Copyright  2005 John Wiley & Sons, Ltd.

Received 20 November 2002 Final revision received 14 September 2004

322

M. V. S. Kumar THEORY AND HYPOTHESES
In the literature on the dynamics of inter-firm collaboration, one theme that has been consistently used to explain the termination of joint ventures is the fact that they are shared governance structures involving the participation of two or more firms. This shared governance structure in turn creates the potential for management conflicts due to cultural differences (Park and Ungson, 1997) and a divergence in goals and values of partner firms (Killing, 1983). A second reason for conflicts arises due to the intrinsic nature of joint ventures which combine elements of competition as well as cooperation. Various metaphors have been used to describe this feature of joint ventures, including prisoner’s dilemma (Parkhe, 1993), learning race (Hamel, 1991), and internal tensions (Das and Teng, 2000). While these studies attribute termination to the shared governance structure of joint ventures, several authors have pointed out there are also other reasons for termination that are independent of this aspect. One particularly important argument in this regard is that the termination of joint ventures is linked to the original motives with which they are formed. When compared to market contracts, joint ventures provide firms with an efficient means for acquiring and exchanging complementary knowledge (Teece, 1986; Hennart, 1988). Once the requisite complementary knowledge is acquired and learning is complete, the costs of cooperation may exceed benefits and there may no longer be a need to sustain the venture. At this stage the parent firms may decide to terminate the venture and pursue their strategic objectives independent of each other. Thus the general principle here is that joint ventures are inherently transitional structures (Williamson, 1996) which terminate once they have achieved their initial objectives. This general principle also underlies the real options view of joint ventures (Kogut, 1991), which provides a theoretical rationale both for the formation as well as the termination of joint ventures. According to the real options view, joint ventures allow firms to pool risks and share the investment at the time of entering into a new market. Although this comes at the cost of relinquishing some degree of administrative control, the benefits are that it provides firms with a relatively inexpensive means of monitoring a new environment while incrementally absorbing skills
Strat. Mgmt. J., 26: 321–331 (2005)

than to the underlying reason for terminating the venture. To gain a better understanding of when acquiring/divesting a venture creates value, it is necessary to examine the reason for termination, given that this would be an important factor that impacts value creation. The purpose of this paper is to address the above gaps in the literature. Toward this objective the paper adopts a real options perspective (Kogut, 1991) as its principal theoretical lens. The real options perspective is particularly suited to the issues at hand since it simultaneously addresses the reason for termination as well as the mode of termination. Two research questions are therefore examined in the paper: (1) When does acquiring a joint venture create value? (2) When does divesting a joint venture create value? Consistent with the real options view, the paper finds that joint ventures divested to refocus a firm’s product market portfolio resulted in significant value creation. In contrast, joint ventures acquired with the objective of growth and expansion in a target market, while not resulting in significant value creation, did not destroy value either. Apart from highlighting the importance of the motive for termination, the real options view also provides added insight into the cross-sectional variation in the value created from termination. Specifically it suggests that terminating ventures in uncertain and concentrated industries would create lesser value, since there is greater potential for upside gains and it pays to ‘keep options open’ in these industries. These hypotheses were also supported in the paper, thus suggesting that while joint ventures confer valuable flexibility as real options, this flexibility is also forgone once they are terminated. The paper hopes to make two main contributions. First, it attempts to complement previous event studies (e.g., McConnell and Nantell, 1985; Woolridge and Snow, 1990; Koh and Venkatraman, 1991; Park and Kim, 1997) by showing that the value created at the time of joint venture formation is not necessarily unwound at the time of termination. Second, while the real options approach provides a coherent framework for understanding investment under uncertainty, one implicit assumption is that investment decisions undertaken consistent with this approach would eventually enhance the performance of parent firms. The present study is an attempt at critically examining this particular assumption in the context of joint venture terminations.
Copyright  2005 John Wiley & Sons, Ltd.

Value from Acquiring and Divesting a Joint Venture
from a partner. Once the necessary skills have been absorbed and the environment in the target market turns favorable, a firm may enhance its commitment by acquiring the venture from the partner. Thus in the real options view, joint ventures act as a bridge between the alternatives of irreversibly committing resources at the time of entering into a new market versus waiting to enter later when conditions prove favorable. Paralleling Williamson (1996), the real options view also suggests that joint ventures act as transitional structures in the sequential growth process of a firm (Gomes-Casseres, 1987; Folta, 1998). Exercising the real option may manifest itself in the form of a firm acquiring the venture from the partner, which in turn serves as a stepping stone for further growth and expansion in the target market. The benefits of acquiring the venture for a parent firm are at least twofold. First, the firm may leverage the knowledge and assets already developed through the venture for further growth and expansion. Second, acquiring the venture also allows the firm to respond to favorable environmental conditions in a timely manner before they are dissipated by competitors. An important variation on the above arguments can be found in the work of Balakrishnan and Koza (1993) and Nanda and Williamson (1995). These authors argue that joint ventures act as a mechanism to circumvent adverse selection problems (Akerlof, 1970) in the market for acquisitions. Thus if there are significant informational asymmetries between a potential buyer and a seller of an asset, the buyer would be unable to ascertain the true value of the asset and stands the risk of buying a ‘lemon.’ A possible solution under these circumstances is to form a joint venture. A joint venture avoids a one-time acquisition transaction and institutes a repeated contracting relationship in its place that induces information revelation. As information is progressively revealed, it facilitates learning and valuation of the asset until a point is reached where the venture ceases to offer any additional advantages. At this point the venture may be terminated and the buyer may acquire the asset from the seller. In contrast to Kogut’s (1991) analysis, the above view implies that joint ventures may be formed to reduce the uncertainty pertaining to the value of an asset possessed by a partner. Thus the uncertainty of focus is endogenous and firm specific,
Copyright  2005 John Wiley & Sons, Ltd.

323

rather than exogenous (Folta, 1998). Such ventures are also likely to be characterized by an explicit buy/sell option (Nanda and Williamson, 1995; cf. Chi, 2000) which could be triggered once the valuation process is complete. Balakrishnan and Koza (1993) also note that the potential for adverse selection is particularly likely when a firm diversifies into markets that are dissimilar to its primary business. In such instances, joint ventures may provide firms with a relatively efficient means of obtaining the required complementary resources when compared to outright acquisitions. The real options view suggests that joint ventures offer a number of advantages in terms of entering into a new market when compared to greenfield investments and outright acquisitions. The general implication of this view is that once the necessary capabilities have been absorbed and learning is complete, a firm may acquire a venture as a step toward further growth and expansion in a target market. In addition, the real options view suggests that such venture acquisitions are likely to have a positive impact on the value of a parent firm. Apart from allowing a timely response to environmental opportunities, a parent firm is likely to be well informed of the value of the venture’s assets and the rents they are capable of generating once they are internalized. This contrasts with an outright acquisition where the parent firm may not possess such information at the time of the acquisition. These arguments suggest the following hypothesis: Hypothesis 1: Joint ventures acquired with the objective of growth and expansion in a target market will result in positive value creation. While the above hypothesis pertains to the conditions under which an acquiring firm gains value, it does not address the value created for the divesting firm. Kogut (1991) argues that a firm may be willing to divest a venture1 if it lacks the independently held complementary resources required to expand in a target market. The absence of independently held complementary resources ultimately drives a wedge between partners’ valuations, thereby enabling one firm (or an external
1 There are three forms this divestiture may take (cf. Reuer, 2000): (1) the firm may divest its share to the other partner(s) in the venture; (2) the firm may divest its share to a third party; (3) all the partners in the venture may divest their shares to a third party.

Strat. Mgmt. J., 26: 321–331 (2005)

324

M. V. S. Kumar
into the future when further information is available pertaining to the target market. A central principle of the real options view is that the flexibility to defer investment is more valuable in uncertain environments (McDonald and Siegel, 1986; McGrath, 1997). In such environments the upside potential that can be exploited is larger, thus making it worthwhile for a firm to wait and gather more information. Extending the principle to joint ventures implies that the flexibility to defer investment provided by ventures in uncertain target markets is likely to be more valuable than in mature target markets. In such target markets waiting has greater value due to the potential for higher upside gains, and due to the possibilities of continued learning (Bowman and Hurry, 1993). But these gains notwithstanding, there are at least three reasons that suggest firms may find it efficient to terminate joint ventures even in uncertain markets: (1) a favorable environmental signal may make it attractive for one firm to acquire the venture; (2) learning may be enhanced when the acquiring firm increases its investment and moves to the next stage of commitment (Folta and Miller, 2002); (3) the costs of sustaining the joint venture may begin to exceed the benefits of flexibility. These costs may include coordination costs, and for the divesting firm the opportunity costs associated with the capital and resources locked in the joint venture (Bowman and Hurry, 1993). Once a firm terminates a venture in an uncertain target market due to these various reasons, the loss in valuable flexibility would also be greater than for a venture terminated in mature target markets. In other words, the flexibility forgone due to termination is likely to be more valuable in uncertain target markets than in mature target markets. Thus: Hypothesis 3: The value gained by acquirers and divesters will be negatively associated with the degree of uncertainty in the target market. In formal terms the intuition behind Hypothesis 3 is as follows: when a firm exercises a real option, it swaps one risky asset (the real option) with another (the revenue stream from the irreversible investment). Thus if V is the present value of the revenue stream from the investment and F is the value of the real option at a particular point in time, the firm’s value will be raised by V − F when the
Strat. Mgmt. J., 26: 321–331 (2005)

firm) to acquire the venture from a partner (Chi, 2000). In such instances the divesting firm exercises its option to abandon the venture while withdrawing from the target market and refocusing its product-market portfolio (Kogut, 1991). There are various reasons to suggest that such venture divestitures would create value for a parent firm. First, they are likely to represent a redeployment of resources toward more profitable opportunities. Evidence from the literature suggests that such divestitures, on average, are associated with value creation (Montgomery, Thomas, and Kamath, 1984; Markides, 1992). Second, when compared to a wholly owned business unit, the firm is likely to incur lower costs in learning whether a particular target market fits with its longterm strategy. Thus the cumulative costs of exiting a target market are likely to be lower in the case of a joint venture when compared to a wholly owned business unit. A similar argument also applies in the case of a joint venture formed to circumvent adverse selection problems in the market for acquisitions. In such instances the ‘pain of restructuring’ (Nanda and Williamson, 1995) is eased for the divesting firm by ensuring a smooth transfer of assets to the acquiring firm, thereby lowering the costs of exit. These arguments suggest the following hypothesis: Hypothesis 2: Joint ventures divested to refocus a firm’s product-market portfolio will result in positive value creation. Hypotheses 1 and 2 focus on the benefits that accrue to firms when they acquire and divest joint ventures. But apart from these benefits, firms also forgo certain benefits when they terminate joint ventures. From a real options standpoint one important benefit that firms forgo is the flexibility to defer investment. As noted previously, joint ventures allow firms to absorb skills incrementally from a partner while monitoring a target market. When a venture is acquired, the acquiring firm commits itself relatively irreversibly to a strategy of growth in that particular target market. Conversely, the divesting firm commits itself to a strategy of exiting that particular target market and redirecting resources toward more profitable opportunities. While these decisions may be taken in response to various internal and external conditions as outlined earlier, by terminating a venture both firms lose the flexibility to defer investment
Copyright  2005 John Wiley & Sons, Ltd.

Value from Acquiring and Divesting a Joint Venture
option is exercised (McDonald and Siegel, 1986; Dixit and Pindyck, 1994).2 In a related vein, Folta (1998) argues that joint ventures are preferable to wholly owned business units and acquisitions in industries where there is less rivalry. In such industries there is a lower risk of preemption, and opportunities are not as fleeting as in industries with greater rivalry. Correspondingly, in industries with greater rivalry, growth options are likely to be vigorously competed and shared by rivals limiting the upside potential that any one firm can earn from these options. This is in contrast to financial options where the gains are contractually established and preemption does not pose a hazard.3 These arguments once again suggest that flexibility has more value in industries with lesser rivalry since firms do not have to commit themselves to immediate growth opportunities and can wait to gather further information. But to the extent that firms terminate ventures in these industries due to factors such as rising costs, the loss in valuable flexibility is also likely to be higher than in industries with greater rivalry: Hypothesis 4: The value gained by acquirers and divesters will be negatively associated with the extent of rivalry in the target market.

325

METHODS
In this study, Hypotheses 1 and 2 pertain to the value created from termination in light of the reasons for acquiring and divesting joint ventures. In contrast, Hypotheses 3 and 4 pertain to the cross-sectional variation in the value created, and the factors that explain this variation. Thus while Hypotheses 1 and 2 involved conducting an event study, Hypotheses 3 and 4 entailed regressing the abnormal returns obtained from the event study on variables capturing target market uncertainty and rivalry. To test these hypotheses, the first step was to develop a sample of joint venture terminations where at least one partner acquired/divested
2 In this paper, Hypotheses 1 and 2 pertain to the net effect (V − F ), while Hypotheses 3 and 4 pertain to factors affecting F . 3 I thank an anonymous reviewer for pointing out this important difference.

the joint venture. Toward this end the Mergers and Acquisitions, Joint Ventures and Divestitures sections of the Wall Street Journal Index were examined for the period 1989–98. The objective was to identify citations related to joint venture termination announcements. The Wall Street Journal was used as the starting point since it is considered the newspaper of record for the financial community (McWilliams and Siegel, 1997). After identifying the citations, the referenced articles were examined to confirm that they pertained to venture acquisitions/divestitures, and to identify parent firms. Next, the following criteria were applied: (1) the venture should be an independent legal entity distinct from each partner; (2) at least one partner should be a publicly listed U.S firm; (3) corresponding stock returns should be available on the Center for Research in Security Prices database (CRSP). The next important consideration was to ensure that there were no confounding events on or around the announcement date for each parent firm. A 4day period around the announcement date [−2, 2] was checked for confounding events (McWilliams and Siegel, 1997) such as dividend and earnings announcements, acquisitions, joint venture formations, restructuring, major contract awards, new product announcements, and labor disputes. After eliminating firms with confounding events, 74 firms were left in the acquisition sample and 62 firms in the divestiture sample. For these firms further details were collected on the venture termination through a search of the Lexis-Nexis database. At this stage emphasis was placed on articles that specifically discussed the reason for termination. This search resulted in articles from a variety of sources, including wire reports, newspaper and magazine articles, and industry publications. Typically the articles provided insight into the reason for termination by quoting the opinions of executives at the parent firm (such as the CEO, CFO), the views of individual analysts tracking companies, or a combination of both. Next, two independent researchers examined the articles to further understand the reason for termination. The researchers then met and discussed the articles to decide whether a particular termination was consistent with the real options view. To test Hypothesis 1, the general rule agreed upon was that the article should specifically highlight how the venture acquisition played a role in the parent
Strat. Mgmt. J., 26: 321–331 (2005)

Copyright  2005 John Wiley & Sons, Ltd.

326

M. V. S. Kumar
the firms in the acquisition and divestiture subsamples were mostly drawn from different joint ventures. There were in fact only five ventures where the value for both the acquiring and divesting firm was examined. This occurred for several reasons, including: (1) some parent firms were foreign based and were consequently not listed on a major U.S. stock exchange; (2) some parent firms were eliminated due to confounding events; (3) the reason for termination was not always available for both partners. In the divestiture subsample there were two instances where both partners sold the venture to a third partner or to an outside firm. In addition, there were eight instances where one partner sold the venture to an outside firm. Both samples comprised parent firms that were drawn from a wide variety of industries, including manufacturing and non-manufacturing sectors. The event study used to test Hypotheses 1 and 2 was conducted by estimating the market model for each firm over the period −250 to −50, with the announcement date serving as 0. Next the abnormal returns were calculated and the Patell (1976) test was used to test for significance. Two non-parametric tests (the binomial test and the Wilcoxon signed rank test) were also employed to examine the significance of abnormal returns. These tests help detect whether there are any outliers driving the event study results (McWilliams and Siegel, 1997). To test Hypotheses 3 and 4, the industries of the joint ventures corresponding to the 46 acquisitions and 39 divestitures were identified at the 4-digit SIC level using the termination news reports and articles. Next, two measures were constructed to capture the degree of uncertainty in each industry. The first measure was the volatility in the value of shipments of the industry in the 10 years prior to termination (Keats and Hitt, 1988). The higher the volatility, the higher the degree of uncertainty. The second measure was a dummy variable based on Scherer’s (1982) classification of industries into regimes of ‘technological opportunity.’ Technological opportunity broadly denotes the opportunities for technological advance and appropriability. The greater the technological opportunity, the more the technological uncertainty and the greater the returns to R&D. A dummy variable was coded for the
Strat. Mgmt. J., 26: 321–331 (2005)

firm’s expansion in a target market. In some cases the articles provided descriptors such as ‘the venture acquisition fits with the company’s strategy to grow in the region’ or ‘the venture acquisition helps the firm expand its business in a strategic market.’ In other cases there were indications that the acquisition provided critical capabilities for expansion through phrases such as ‘the venture acquisition helps improve customer service levels’ and ‘the venture acquisition will enable the company to strengthen local market products.’ Apart from these reasons, there were three instances where a parent firm exercised an option to acquire a venture from a partner which were also included in the sample. This process also revealed that not all venture acquisitions were motivated with the objective of expansion in a target market. For example, in 11 cases the acquisition appeared to have been prompted by a parent firm’s need for more flexibility and control over the joint venture (cf. Gomes-Casseres, 1987). In three other cases a parent firm acquired a venture to improve its performance through sole ownership, while in one case the venture was acquired to resolve a management conflict between partners. There were also 13 instances where there was no reason available for the venture acquisition. After eliminating these firms, 46 firms were left in the acquisition sample. A similar procedure was also followed to identify a sample of firms for testing Hypothesis 2. This process was relatively straightforward since in most cases the articles specifically discussed how the venture divestiture helped a parent firm refocus its operations. Thirty-nine parent firms were identified where this was the primary reason behind the venture divestiture. As with venture acquisitions, once again there appeared to be a variety of motives underlying venture divestitures. In five cases a parent firm divested a venture to raise cash and ease liquidity pressures, in two cases in response to management conflicts, and in two other cases because it felt it lacked the flexibility as a minority partner. There were also 10 firms where there was no reason given for the venture divestiture. The 46 acquisitions and 39 divestitures belonged to 78 different joint ventures. Of these 78 ventures, 46 involved one non-U.S. partner, while the remaining 32 ventures were between U.S.-based firms. Five ventures had more than two partners, and 73 ventures involved two firms. Note that
Copyright  2005 John Wiley & Sons, Ltd.

Value from Acquiring and Divesting a Joint Venture
top two industry groups with the greatest technological opportunity (electronics and organic chemicals), while the remaining five industry groups served as the reference (electrical, mechanical, chemical, traditional, and metal industries). The technological opportunity dummy and the volatility of shipments were expected to capture two different dimensions of uncertainty in the industry. Thus, while the former reflects technological uncertainty, the latter broadly captures demand uncertainty. Following Hypothesis 3, both these variables were expected to be negatively correlated with the abnormal returns for acquirers and divesters. In terms of measuring the extent of rivalry to test Hypothesis 4, one option was to find the number of rivals operating in each joint venture industry (cf. Folta, 1998). But since data were not available, the Herfindahl index in 1992 was used as an approximation. The higher the Herfindahl index, the lower the degree of rivalry. Thus Hypothesis 4 suggests the Herfindahl index will be negatively correlated with the abnormal returns for acquirers and divesters.
Table 1. Ventures acquired with the objective of growth and expansion (n = 46) Event day −1 0 1 Abnormal returns −0.04% −0.24% −0.01%

327

Table 2. Ventures divested to refocus a firm’s product-market portfolio (n = 39) Event day Abnormal returns −1 0 1

Z −0.940 2.887∗ −0.764

Wilcoxon z −0.890 2.590∗ −1.270

+ves/ −ves 17 : 22 25 : 14 14 : 25

−0.18% 0.63% −0.12%

p < 0.01, one tailed

RESULTS
Table 1 presents the results for the 46 firms which acquired a venture with the objective of growth and expansion in a target market. Event study results are presented for days −1, 0 and +1, since longer windows would have been contaminated by confounding events. Table 1 shows that the 46 firms experienced insignificant abnormal returns on the day of the announcement. Further, the abnormal returns were also insignificant for days −1 and +1. Both the non-parametric tests were also insignificant for all three event days. Thus Hypothesis 1 was not supported by the data.4 Table 2 shows that firms that divested a venture to refocus their product-market portfolio experienced significant (p < 0.01) positive abnormal returns on the day of the announcement. The abnormal returns were on average 0.63 percent, representing a value of U.S. $87m. Further, both the binomial (p < 0.10) and the Wilcoxon signed tests (p < 0.01) were also significant and in the
4

Similar results were obtained for the 28 acquiring firms which were not included in the sample.

predicted direction for day 0. These results provide strong support for Hypothesis 2. As a further test of Hypothesis 2 an event study was also conducted for the 23 firms which divested a venture for reasons other than refocusing. The event study results indicate that the abnormal returns for these 23 firms were insignificant on all three event days. Taken together these results suggest that not all venture divestitures create value, and that the motive for termination plays an important role in value creation. Table 3 presents the results of regressing the day 0 abnormal returns for the acquirers and divesters on the uncertainty variables and the Herfindahl index. Since the independent variable data could only be obtained for manufacturing industries, the sample size was reduced to 27 firms in each category. The results in Table 3 are consistent with Hypotheses 3 and 4, and with the predictions made by real options theory. The dummy variable denoting electronics/organic chemical industries is negatively associated with the abnormal returns for both acquirers and divesters. The volatility of industry shipments is negatively associated with the abnormal returns for divesters, indicating support for Hypothesis 3. Table 3 also shows that the Herfindahl index is negatively associated with the day 0 abnormal returns for acquirers. This indicates moderate support for Hypothesis 4 and the notion that
Strat. Mgmt. J., 26: 321–331 (2005)

Copyright  2005 John Wiley & Sons, Ltd.

328
Table 3.

M. V. S. Kumar
Regression of day 0 abnormal returns I II −0.0009 1.4e–09 0.661 1.22 0.092 −0.0003 −2.12e–08 ∗ 2.74∗ 2.96 0.198 III −0.0011† −1.682† 3.4e–10 1.182† 2.10 0.215 −0.0003 −0.852† −1.73e–08† 1.304∗ 3.08 0.2857

Acquirers (n = 27) Herfindahl index Dummy for electronics/organic chemicals Volatility in industry shipments Constant F R2 Divesters (n = 27) Herfindahl index Dummy for electronics/organic chemicals Volatility in industry shipments Constant F R2
†p < 0.10, one tailed; ∗ p < 0.05, one tailed

−0.0011† −1.652† 1.844† 3.28 0.2145 −0.0003 −1.056∗ 1.103∗ 2.61 0.178

valuable flexibility is forgone when firms terminate joint ventures in less rivalrous industries.5 Two further points are worth noting about the results in Tables 1–3. First, Table 3 shows that firms stand to gain lesser value when they acquire joint ventures in concentrated industries. This result is in contrast to the argument that firms would gain more value when they acquire assets in these industries, given that these industries may be structurally more attractive (Porter, 1980). This suggests that joint ventures create value not only due to the net present value of their assets (or what is termed as assets in use; Myers, 1977), but also due to growth options and flexibility. Second, it could also be argued that the day 0 abnormal returns reported in Tables 1 and 2 are reflecting portfolio-restructuring effects associated with acquiring and divesting business units, rather than the real option benefits conferred by joint ventures. Thus it is possible that divesters are gaining value because they are divesting unrelated business units, and acquirers are not losing value because they are expanding into related fields. To explore this issue further, the primary SIC code of the 27 acquirers and 27 divesters was retrieved from the Compustat database. Next, based on the primary SIC code and the 4-digit SIC of the venture’s industry, the inter-industry relatedness measure
5 While the small sample sizes in Table 3 raise a caution flag, there were no outliers driving the results and there was no evidence of heteroskedasticity. Further, including firm size as a control did not affect the results.

was obtained from Robins and Wiersema (1995).6 Broadly speaking, this measure reflects the degree of relatedness between the core business of the parent and the target market of the venture. This relatedness measure was then included as a control in the regressions in Table 3. The inclusion of the control did not significantly affect the results, indicating that portfolio-restructuring effects were not influential in explaining the cross-sectional variation in abnormal returns.

DISCUSSION
This study examines the value created from acquiring and divesting a joint venture by adopting a real options perspective. Unlike previous research which has either focused on different modes of termination (e.g., Reuer, 2001), or has examined the impact of various parent firm factors (e.g., Reuer, 2001), the study looked at the reason behind the termination of the venture and the characteristics of the target market. The event study results suggest that ventures acquired with the objective of growth and expansion in a target market did not lead to value creation. On the other hand, ventures divested with the objective of refocusing a
6 The inter-industry similarity measure is calculated in Robins and Wiersema (1995) as follows: First industries are divided into 37 groups based on Scherer (1982). Next, for each group a vector of technology inflows from all other groups is formed. The interindustry similarity measure is basically the correlation between the vectors of two industries.

Copyright  2005 John Wiley & Sons, Ltd.

Strat. Mgmt. J., 26: 321–331 (2005)

Value from Acquiring and Divesting a Joint Venture
firm’s product market portfolio were associated with significant value creation. Although the venture acquisitions examined in this study were not associated with positive abnormal returns, it is worth noting that they did not significantly destroy value either. Partly this may be due to the advantages associated with acquiring a joint venture where, unlike an outright acquisition, the firm is likely to have better information on the assets being acquired (cf. Balakrishnan and Koza, 1993; Nanda and Williamson, 1995). This issue notwithstanding, the insignificant results also suggest that there may be other explanatory factors at work in influencing the abnormal returns. For example, one important assumption behind Hypothesis 1 was that firms have developed the necessary capabilities through the venture to expand on their own in the target market (Kogut, 1991). To the extent that this assumption was not valid and some firms in the sample acquired the venture before completing learning, it is possible that there may have been no significant value creation. In contrast, the results suggest that divesting joint ventures with the objective of refocusing a firm’s product-market portfolio were associated with significant value creation. This result attests to the utility of joint ventures as a means for exploring new markets. Further, it also supports the central argument in the real options view that joint ventures provide firms with a relatively inexpensive means of monitoring an environment, while providing the flexibility to increase or decrease commitment. Two additional implications can be derived from this result. First, like any business unit, a joint venture needs to be divested keeping in view the firm’s underlying strategy with respect to the target market. Thus divesting a venture due to short-term considerations may not lead to value creation, as evidenced by the insignificant results for the full sample of 62 divesters (cf. Montgomery, Thomas, and Kamath, 1984). Second, there has been some debate in the literature about the psychological and organizational factors concerning the abandonment of real options. Some scholars (e.g., Adner and Levinthal, 2004) have suggested that, due to factors such as hubris and escalating commitment, firms may sustain real options beyond what is optimal and may resist abandoning them. The results of this study seem to suggest that this may not be the case for joint ventures. Partly this may be due to the fact that, unlike
Copyright  2005 John Wiley & Sons, Ltd.

329

other investments, joint ventures may be easier to abandon since they can be sold to a partner. Thus the firm may not have to incur extensive search costs in locating potential buyers and liquidating assets, which may make abandoning joint ventures relatively less prone to psychological biases. Apart from these implications, the study’s findings also highlight an important caveat with regard to termination. Firms also forego valuable flexibility and trade it off for commitment when they terminate joint ventures. This implication follows from the negative impact of target market characteristics such as volatility and the extent of rivalry on the cumulative abnormal returns. From a managerial standpoint, managers need to be aware of this important trade-off and take it into account when they terminate joint ventures. From a theoretical standpoint, these results imply that while investment decisions taken consistent with the real options view are value creating, unlike financial options, there are non-trivial costs associated with maintaining and sustaining real options (Folta and Miller, 2002). To the extent that these costs are higher than originally anticipated and offset the benefits of flexibility, they may prompt the exercise of real options even when the target market is uncertain and there is a low risk of preemption. At a more general level, this study’s findings also indicate that the value created at the time of joint venture formation is not necessarily destroyed at the time of termination. Thus, while the longevity of a venture may be a sign of success, terminating a venture does not necessarily imply that it has failed to achieve its strategic objectives (cf. Geringer and Herbert, 1991). This is consistent with the view that termination may often be an integral part of the evolution of joint ventures, and the fact that they have a finite life does not reduce their importance as a vehicle for achieving strategic objectives. Future research could build on this research in several ways. First, while this study uses an event study methodology, it may be useful to complement the findings with more direct measures such as managerial assessments of the performance impact of acquiring and divesting a venture. Second, the study focuses mainly on the termination stage of joint ventures. However, termination may often be preceded by instability (Yan and Zeng, 1999; Reuer, Zollo, and Singh, 2002) where partners may make structural changes to a venture.
Strat. Mgmt. J., 26: 321–331 (2005)

330

M. V. S. Kumar
Geringer JM, Herbert L. 1991. Measuring performance of international joint ventures. Journal of International Business Studies 22: 249–263. Gomes-Casseres B. 1987. Joint venture instability: is it a problem? Columbia Journal of World Business 22: 97–102. Hamel G. 1991. Competition for competence and inter-partner learning within international strategic alliances. Strategic Management Journal , Summer Special Issue 12: 83–103. Harrigan KR. 1988. Strategic alliances and partner asymmetries. In Cooperative Strategies in International Business, Contractor FJ, Lorange P (eds). Lexington Books: Lexington, MA; 205–226. Hennart J-F. 1988. A transaction costs theory of equity joint ventures. Strategic Management Journal 9(4): 361–374. Hennart J-F, Kim D-J, Zeng M. 1998. The impact of joint venture status on the longevity of Japanese stakes in U.S. manufacturing affiliates. Organization Science 9: 382–395. Keats BW, Hitt MA. 1988. A causal model of linkages among environmental dimensions, macro organizational characteristics, and performance. Academy of Management Journal 31: 570–598. Killing JP. 1983. Strategies for Joint Venture Success. Praeger: New York. Kogut B. 1989. The stability of joint ventures: reciprocity and competitive rivalry. Journal of Industrial Economics 38: 183–198. Kogut B. 1991. Joint ventures and the option to expand and acquire. Management Science 37: 19–33. Koh J, Venkatraman N. 1991. Joint venture formations and stock market reactions: an assessment in the information technology sector. Academy of Management Journal 34: 869–892. Markides CC. 1992. Consequences of corporate refocusing: ex ante evidence. Academy of Management Journal 35: 398–412. McConnell JJ, Nantell TJ. 1985. Corporate combinations and common stock returns: the case of joint ventures. Journal of Finance 40: 519–536. McDonald R, Siegel, D. 1986. The value of waiting to invest. Quarterly Journal of Economics 101: 707–728. McGrath R. 1997. A real options logic for initiating technology positioning investments. Academy of Management Review 22: 974–996. McWilliams A, Siegel D. 1997. Event studies in management research: theoretical and empirical issues. Academy of Management Journal 40: 626–657. Montgomery CA, Thomas AR, Kamath R. 1984. Divestiture, market valuation, and strategy. Academy of Management Journal 27: 830–840. Myers SC. 1977. Determinants of corporate borrowing. Journal of Financial Economics 4: 147–175. Nanda A, Williamson PJ. 1995. Use joint ventures to ease the pain of restructuring. Harvard Business Review 73(6): 119–132. Park SH, Kim D. 1997. Market valuation of joint ventures: joint venture characteristics and wealth gains. Journal of Business Venturing 12: 83–108.
Strat. Mgmt. J., 26: 321–331 (2005)

While there was relatively little evidence of instability in the sample used in this study, it may be useful to conduct a study of the value associated with these structural changes as well. Finally, apart from joint venture terminations, future research could examine the value implications of terminating other types of real options such as increasing minority investments to full ownership in partner firms.

ACKNOWLEDGEMENTS
I would like to thank Mark Hansen and Jelena Spanjol for comments, and Emre Imamoglu for research assistance. Special thanks are also due to two anonymous reviewers without whose help this paper would not have been possible. Responsibility for any remaining errors is mine.

REFERENCES
Adner R, Levinthal D. 2004. What is not a real option: considering boundaries for the application of real options to business strategy. Academy of Management Review 29: 74–85. Akerlof GA. 1970. The market for ‘lemons’: qualitative uncertainty and the market mechanism. Quarterly Journal of Economics 84: 488–500. Balakrishnan S, Koza MP. 1993. Information asymmetry, adverse selection and joint ventures: theory and evidence. Journal of Economic Behavior and Organization 20: 99–117. Bleeke J, Ernst D. 1995. Is your strategic alliance really a sale? Harvard Business Review 73(1): 97–105. Bowman EH, Hurry D. 1993. Strategy through the options lens: an integrated view of resource investments and the incremental-choice process. Academy of Management Review 18: 760–782. Chi T. 2000. Option to acquire or divest a joint venture. Strategic Management Journal 21(6): 665–687. Das TK, Teng B-S. 2000. Instabilities in strategic alliances: an internal tensions perspective. Organization Science 11: 77–101. Dixit AK, Pindyck RS. 1994. Investment under Uncertainty. Princeton University Press: Princeton, NJ. Dussauge P, Garrette B, Mitchell W. 2000. Learning from competing partners: outcomes and durations of scale and link alliances in Europe, North America and Asia. Strategic Management Journal 21(2): 99–126. Folta TB. 1998. Governance and uncertainty: the trade off between administrative control and commitment. Strategic Management Journal 19(11): 1007–1028. Folta TB, Miller KD. 2002. Real options in equity partnerships. Strategic Management Journal 23(1): 77–88.
Copyright  2005 John Wiley & Sons, Ltd.

Value from Acquiring and Divesting a Joint Venture
Park SH, Russo MV. 1996. When competition eclipses cooperation: an event history analysis of joint venture failure. Management Science 42: 875–890. Park SH, Ungson GR. 1997. The effect of national culture, organizational complementarity, and economic motivation on joint venture dissolution. Academy of Management Journal 40: 279–307. Parkhe A. 1993. Strategic alliance structuring: a game theoretic and transaction cost examination of interfirm cooperation. Academy of Management Journal 36: 794–829. Patell JN. 1976. Corporate forecasts of earnings per share and stock price behavior: empirical tests. Journal of Accounting Research 14: 246–276. Porter ME. 1980. Competitive Strategy. Macmillan: New York. Porter ME. 1987. From competitive advantage to corporate strategy. Harvard Business Review 65(3): 43–59. Reuer JJ. 2000. Parent firm performance across international joint venture life-cycle stages. Journal of International Business Studies 31: 1–20. Reuer JJ. 2001. From hybrids to hierarchies: shareholder wealth effects of joint venture partner buyouts. Strategic Management Journal 22(1): 27–44. Reuer JJ, Miller KD. 1997. Agency costs and the performance implications of international joint venture internalization. Strategic Management Journal 18(6): 425–438. Reuer JJ, Zollo M, Singh H. 2002. Post-formation dynamics in strategic alliances. Strategic Management Journal 23(2): 135–151. Robins J, Wiersema MF. 1995. A resource based approach to the multibusiness firm: empirical analysis of portfolio interrelationships and corporate financial performance. Strategic Management Journal 16(4): 277–299. Scherer, FM. 1982. Demand-pull and technological invention: Schmookler revisited. Journal of Industrial Economics 30: 225–237. Teece DJ. 1986. Profiting from technological innovation: implications for integration, collaboration, licensing and public policy. Research Policy 15: 285–305. Williamson OE. 1996. The Mechanisms of Governance. Oxford University Press: New York. Woolridge JR, Snow CC. 1990. Stock market reaction to strategic investment decisions. Strategic Management Journal 11(5): 353–363. Yan A, Zeng M. 1999. International joint venture instability: a critique of previous research, a reconceptualization, and directions for future research. Journal of International Business Studies 30: 397–414.

331

Copyright  2005 John Wiley & Sons, Ltd.

Strat. Mgmt. J., 26: 321–331 (2005)