A company’s announcement that it is undertaking a “review of strategic alternatives” is Wall Street code for exploring a potential sale or merger. Though no transaction may occur, the announcement signals that the company is due for a shake up, with some sort of strategic change likely. Because such disclosures are voluntary,[1] directors and the CEO should carefully consider whether to announce the strategic review.

Some companies evaluate their strategic alternatives privately, often engaging a financial adviser and appointing a committee of independent directors. Other companies will, in addition, issue a press release and file an associated 8-K to publicly announce the review. See examples of announcements made by Western Digital and Albertsons in 2022.

Whether to make this news public is a key decision since it can have significant consequences that affect investor reactions, the subsequent sale process (should one occur), firm operations, employees, and ultimately firm value. Some business leaders and advisers view an announcement as desirable, while others view it as a public admission of problems that creates a negative perception. In a recent paper, I look for empirical evidence supporting arguments on both sides.

The Facts About Disclosing Strategic Alternatives

A variety of strategic alternatives are available to a company facing significant challenges, including a sale, a divestiture, or a restructuring. Based on a sample of 1,239 announcements that a company is evaluating strategic options, I document an initial 5 percent increase in the price of the announcing company’s stock. Within the subsequent year, 41 percent of the companies in the sample receive at least one public M&A offer (compared with a 7 percent baseline of non-announcing peer firms). Thirty-two percent of the companies in the sample are successfully sold or merged within a year (compared with a 5 percent baseline).

Here are the most prevalent attributes of the announcements in the sample:

• 82 percent mention a financial or legal adviser.
• 78 percent mention the word “strategic.”
• 65 percent state explicitly that the sale of the company is under consideration.
• 63 percent state that the initiative is undertaken to enhance or maximize shareholder value.

(1), (3), and (4) above are correlated with a greater market reaction on the announcement day. (1) and (4) are not predictive of future M&A bids or sales, but mentioning the possible sale of the company (3) is associated with a completed sale.

The Benefits of Disclosing Strategic Alternatives

A public announcement casts the widest net for potential bidders, resulting in a more robust M&A sales process and, ultimately, a greater likelihood of obtaining the associated acquisition premium. I examine various ways of measuring these results and demonstrate that the announcement leads to an abnormally high number of downloads of the firm’s SEC filings, a greater number of public M&A offers, bids from outside the announcing firm’s industry, and higher deal value.

When announcing firms are merged or sold, shareholders experience 34 percent market-adjusted returns in the long-run, reflecting the acquisition premium. For peer firms that have fundamentals similar to those of the announcing firms and are sold or merged, shareholders experience relatively modest 24 percent market-adjusted returns. This suggests an extra 10 percent acquisition premium associated with the voluntary disclosure.

When evaluating the possible benefits of disclosure, leadership should consider whether a public announcement, incremental to a financial adviser’s efforts, can attract additional suitors. They should also consider whether any ideal bidders might sit out the process if it appears too competitive.

In addition, if there is already uncertainty and speculation surrounding the company, an official corporate communication may allow the company to control the information about it.

Directors may also consider how a public disclosure may help satisfy their Revlon duties, which are triggered by a potential sale of control. The board may be required to show, under the enhanced scrutiny standard of review, that it acted reasonably to obtain the best transaction available to maximize shareholder value. The public announcement serves to inform all potential bidders, and a waiting period before any merger agreement allows other bidders to emerge with a better offer.

Risks to Stakeholders and Firm Operations

Announcing strategic alternatives can introduce uncertainty and disruption to the business. These announcements can also signal desperation and lead to instability as stakeholders like customers and employees are alienated by the threat of a change in control:

• Customers and suppliers may curtail or stop doing business with the company. I demonstrate that firms’ revenues and operating income drop in an average amount equal to 1 percent of their total assets after they announce strategic reviews.
• Employee distraction or loss of morale can cause employees to be less productive or leave. In addition to negative effects on operations, firms that announced strategic alternatives lost, on average, 10 percent of their employees in the subsequent year.

In both points above, the estimated effects are relative to peer firms that have fundamentals similar to those of the announcing firms.

If the exploration of strategic alternatives does not result in a consummated transaction with an associated acquisition premium, these negative consequences will contribute to lower share prices as the initial gains prompted by the announcement more than dissipate.

In judging the potential risks, leaders should consider how robust the company culture is and whether employees will be disrupted or jump ship if made aware that the company is evaluating strategic alternatives. Leaders should also consider how easily they may lose customers to competitors. Any decision to voluntarily disclose should include a communications plan to mitigate fallout with these stakeholders.

Conclusion

The decision to publicly announce the exploration of strategic alternatives marks a significant corporate event. Increased transparency can lead to a better M&A outcome yet also lead to the withdrawal of stakeholder support and the disruption of business as usual.

If a transaction results, the total returns to shareholders are about 10 percent higher than they would be if the company had not pre-emptively disclosed. However, if there is no sale or merger, the initially positive market reaction will reverse, leading to an overall loss of value.

The following figure shows long-run buy-and-hold stock returns for the sample of announcing firms and non-announcing peer firms, with the green lines representing companies that are subsequently acquired and the orange lines companies that are not acquired. Stock returns are measured over trading days [-10, +252] relative to the announcement. The overall stock market return has been subtracted from all lines.

ENDNOTE

[1] Basic v. Levinson 1988.

This post comes to us from Professor Jenny Zha Giedt at the George Washington University School of Business. It is based on her recent paper, “Economic Consequences of Announcing Strategic Alternatives: A Voluntary Disclosure’s Benefits and Costs,” available here.