Question

1. In class, we address the importance of maximizing shareholders’ wealth. However, it seems like maximizing stock prices does not make sense, because investors focus on short-term results and do not care about long-term consequences. What do you think? Please discuss.

2. In February, Cap Inc. announced that it would split into two independent publicly traded companies: one comprised of its Old Navy brand, and the second a yet-to-be-named company that includes its other brands like Banana Republic and Athleta. The planned breakup is an acknowledgment of the two chains' diverging fortunes and how much Gap has lost its once-powerful grip on American consumers. For several years, Old Navy has outperformed its sister brands Gap and Banana Republic with its lower price-points and catchy marketing. Old Navy now exceeds the original brand in sales, making up nearly half of Gap Inc.'s $16.6 billion of sales in 2018.

In your opinion, what are the benefits and downsides to splitting Gap into two firms? How did Gap's stock react to the news in after-market trading? How would you explain this reaction? Will the separation save the company in the long run? Please elaborate on your answers.

Answer 1

1). Empirical evidence does not suggest that markets react favorably only when corporate actions are deemed to lead to short term increase in prices. Markets usually react favorably to actions which may not yield results in the short term but are beneficial for the company in the long term. Additionally, it is not necessary that companies which focus on short term results will always be backed by those investors who want short term results.

2). Old Navy has a different business model than specialized brands like Banana Republic and Athleta.So, splitting these into two separate companies makes sense as both require different management strategies. Also, this ensures that the value of one brand does not cover up the loss from other brands which would be the case if every brand was functioning under the same company. The downside can be that the specialized brands which are not faring well may show worsening performance as the value addition from Old Navy is not present any more and the company's diversification (in terms of products and customer base) takes a hit.

Gap's stock rose after the news of spinning off Old Navy as a separate public company. This makes sense as the value of Old Navy can now be tapped into separately without it getting diluted due to other brands. Also, the splitting sends a message that the management is going to take measures to revive the brands which are not faring so well.

If the company is successful in reviving the specialized brands then the splitting can save Gap in the long run.