A Study of Corporate Restructuring in India with Special Focus on Demergers

Abstract

The study broadly examines the motivations for demergers, the announcement effects of demergers and the impact of demergers on performance, profitability, efficiency and valuation of the companies in the Indian context. The announcement impact of the demerger on shareholders wealth is examined using Event Study methodology. Based on the results, it is concluded that demerger announcements increase shareholders wealth in India and that the Indian Stock Market exhibits semi-strong form efficiency with respect to the event examined in this study. The impact of demergers on performance is examined using a Free Cash Flow analysis. The results reveal that there is no significant difference in the Free Cash Flow returns for the postdemerger period as compared to the period prior to the demerger both in case of the Parent company as well as the Resulting company. There is a negative impact on the Free Cash Flow returns at a Consolidated level. The sources of the changes in the Free Cash Flow returns are examined and there is no significant difference in the operating cash flow returns on account of demerger in the post-demerger period. It is also observed that there is no impact of demergers on the working capital position of the companies. While there is a reduction in Capital expenditure in case of Parent companies, it is not statistically significant. In case of Resulting companies, there is a significant increase in Capital expenditure in the postdemerger period. This indicates that after the demerger, Resulting companies are able to take independent decisions and make long term investments. The impact of demergers on the valuation of the companies is examined based on the Enterprise Value after the demerger. There is an increase in the Enterprise Value both in case of Parent companies as well as Resulting companies in the post-demerger period. While the increase in case of Parent companies is not statistically significant, in case of Resulting companies, the increase is statistically significant. The study looks at the factors that contribute to the increase in the Enterprise Value. While Focus has a positive impact on the Enterprise Value, it is significant only in case of Resulting companies. Profitability of the Parent companies prior to the demerger does not seem to have any impact on the Post- Demerger Enterprise Value. Age of the Parent company, low Financial leverage and majority Promoter holding have a positive impact on the Post-Demerger Enterprise Value of the Resulting companies. In order to understand the motivations for Parent companies to undertake a demerger, the strategic decisions taken by the Parent companies during the initial period of 3 years following the demerger are examined. It was observed that during this period, Parent companies representing 75 % of the sample had implemented various financial and business restructuring proposals which were strategic in nature. It is therefore evident that Parent companies have an overall corporate objective in mind and the demerger seems to create the pathway for the Parent company to implement other strategic proposals after the conclusion of the demerger. Based on the study, overall, only the Resulting companies benefit on account of demerger in the long run by way of increase in the Enterprise Value.