Academic journal article Financial Management

The Information Content of Plant Closing Announcements: Evidence from Financial Profiles and the Stock Price Reaction

Academic journal article Financial Management

The Information Content of Plant Closing Announcements: Evidence from Financial Profiles and the Stock Price Reaction

Article excerpt

* A plant closing announcement provides information not just for the plant being closed but also for other operations and the firm as a whole. Examination of financial profiles for firms announcing plant closings indicates that closings are followed by firm-wide problems extending far beyond the closed plant itself. Closings tend to be followed by declining profitability and symptoms of retrenchment including cutbacks in employment, asset acquisition, and dividend growth. Such firm performance subsequent to the closing indicates that the information effect of the announcement should not be limited to the closed plant, but may instead extend to the entire firm.

Downward revision of cash flows by investors should result in a negative market reaction to the closing announcement, with the strength of that reaction related to the information effect of the closing for the entire firm's operations. Results of this study provide evidence of a negative stock price reaction to plant closing announcements. The stock price reaction is more negative for closing announcements of plants whose cash flows are highly related to the firm's entire operations and for plants that comprise a large portion of the firm's operations. Consistent with the analysis of financial profiles, the tests of market reaction to the announcement also demonstrate that plant closing announcements convey information not only about the particular plant being closed, but also about the firm's entire operations.

Section I of this paper examines the plant closing decision and its information content. Section II describes the data sources. Section III presents the financial profile and changes in the financial characteristics of firms surrounding annoucements of plant closings. This analysis is followed in Section IV by an examination of the impact of plant closing announcements on shareholders' wealth categorized by the reasons for plant closings, the relative size of the closing, and relatedness of the closed plant to the firm's other operations. Section V presents concluding remarks.

I. The Plant Closing Decision and Its Information Effect

A. NPV Effects of a Closing Decision and Its Information Effect

A plant closing decision is undertaken when the closing has positive net present value; that is, when the discounted value of cash flows from operating the plant is less than the expected cash benefits of closing its (Robicheck and Van Horne [14], Dyl and Long [7], and Joy [9]). When a plant is closed and idled (not sold), except for some tax benefits or salvage value of assets,(1) the only benefit is avoiding future cash flow losses. This loss avoidance is the source of positive NPV from closure.

To the extent that closed plants comprise a small fraction of the firm's operations, the NPV impact should be small and difficult to measure in an event study. Market reaction to the announcement should be attributed primarily to the information effect of the announcement, and related to changes in investor expectations of firm performance subsequent to the announcement and its consummation.

B. Information Effects of a Closing Announcement

1. The Direction of the Stock Market Reaction

Although a closing announcement indicates positive net present value attached to the closing, it also indicates that the plant in question is worthless and that any operating options (Mason and Merton [12], and Trigeorgis and Mason [17]) for future investments have become worthless as well. Unless investors had some reason to have been aware of the plant's true value, the closing announcement should cause a downward revision in cash flow expectations for at least that plant, and, perhaps, for other related plants as well. The information effect of a closing announcement would therefore be negative.

If, instead, investors had been aware of the true value of the plant or of the firm's problems, but anticipated nevertheless that the plant would remain in operation,(2) the closing announcement should be met with a positive stock price reaction. …

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