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A Study of Two‐Step Spinoffs
Author(s) -
Low Audra L.
Publication year - 2002
Publication title -
financial markets, institutions and instruments
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.386
H-Index - 23
eISSN - 1468-0416
pISSN - 0963-8008
DOI - 10.1111/1468-0416.11404
Subject(s) - dividend , equity (law) , fiduciary , stock (firearms) , business , institutional investor , financial economics , index fund , economics , accounting , monetary economics , finance , corporate governance , political science , law , open end fund , duty , engineering , mechanical engineering
In the last decade, spinoffs have become increasingly popular with firms seeking to divest a part of their businesses. Most of these spinoffs involve a pro-rata distribution of shares in a wholly owned subsidiary to the shareholders of the firm in the form of a dividend. After the distribution, both parent and subsidiary initially share the same shareholder base, even though the operations and management of the two entities are now separate and independent of each other. Another important feature of a spinoff that sets it apart from other types of corporate divestitures is that it does not provide the parent with any cash infusion. Recently, there has been a noticeable trend towards two-step spin off transactions, where parent firms first sell up to 20% of the shares in the subsidiary in an initial public offering, followed shortly by a distribution of the remaining shares to its shareholders. The 20% limit is usually observed in the first step in order to preserve the tax-free status of the transaction. Why firms choose to pursue a two-step spinoff instead of a 100% pure spinoff is unclear. Previous research generally focuses on pure spinoffs, so this question has been yet to be addressed. A possible reason for this is to avoid the dip in the stock price that the spun off subsidiary usually experiences in the first few months following the distribution. This initial stock price decline is usually associated with the portfolio rebalancing activities of large institutional investors whomay not wish to hold the shares of the subsidiary given away by the parent in a spinoff transaction. For example, the manager of an index fund may be required to sell the shares of the spin-off subsidiary if that subsidiary does not form part of the index. In a two-step spinoff, the minority carve-out enables the parent firm to create an orderly market for the new issue and avoid flooding the market with a large number of shares all at once as in the case of a pure spinoff (Lamont and Thaler, 2000). Also, since the carve-out takes the form of an IPO, investment banks are often committed to help support and market the new issue – a feature that is conspicuously absent in a spinoff transaction. Hence, when the spinoff takes place, the market may be better positioned to support the portfolio rebalancing activities highlighted above. In this paper, we seek to validate this strategy by comparing empirically the shareholder wealth effects of one-step spinoff transactions and their two-step