The Impact of Taxes on the Choice of Divestiture Method

This paper estimates the magnitude of tax costs and their impact on the decision to divest assets via taxable sales rather than tax-free spin-offs. We find that the tax costs are substantial, averaging 8% of market value of the divested assets, and that cross-sectional variation in tax costs has a large impact on manager choice of divestiture method. Our results are consistent with two explanations: first, managers are willing to incur avoidable tax costs to gain earnings and cash flow benefits; and second, managers choose taxable sales because the acquisition premia on the sales exceed the avoidable tax costs.