Corporate Spin-Off: Assymetric Information
by
Suresh Deman
Senior Consultant & Honorary Director, Mayo-Deman Consultants
Coauthors: Kim Yong (University of Manitoba)

ABSTRACT

A spin-off occurs when a firm distributes all of its common shares in a controlled subsidiary to its current shareholders, and thus creates a separate public firm. The creation of an independent firm results in a corresponding reduction in the divesting firm's asset base.

A number of studies have examined the effect of divestures on the divesting firm's share value. Alexander, Benson and Kampmeyer (1984) have reported positive abnormal returns on the divesting firm's stock on the date of sell-off announcement. This is similar to the effect of mergers on the target shareholders' wealth to the extent that changes in control of assets result in synergy. That is, if the buyer can utilize the asset better than the seller, then the buyer would be willing to pay a premium for such an asset. Similar announcement effects of spin-offs on the divesting firm's share value have been reported by Hite and Owers (1983), Miles and Rosenfeld (1983), and Schipper and Smith (1983), among others.

The management of the controlled subsidiary is usually promoted via spin-offs to the management of the newly created independent firm, which implies that there are no apparent changes in control of assets. Hence, it is not clear whether the net gains to the shareholders' wealth can be attributed to synergy as in sell-offs. Galai and Masulis (1976) have predicted that spin-offs can result in the wealth transfer from the bondholders to the shareholders as the underlying firm's asset base is reduced. However, empirical evidence in the above studies do not support wealth transfer hypothesis as the bond prices do not change significantly on the announcement date.

The main contribution of the paper is to provides a theoretical rationale for the corporations' spin-off decision and the subsidiaries' investment decision when the manager of the firm has a better information about the subsidiary's investment opportunities than the investors in the market. It is assumed that the manager of the firm knows more about the subsidiary's investment opportunity than investors in the market, and the value of asset-in-place is known to all. By using Kreps and Wilson's (1982) sequential equilibria concept, authors show that only those firms who anticipate investing in a large scale, profitable project in one of their subsidiaries spin off the subsidiary at date 0, and the spun-off subsidiaries who realize the profitable project in a large scale raise the necessary external equity capital at date 1. Further, investors price the shares based on the manager's decisions on the spin-off and the subsidiary financing so that investors' beliefs at each stage are consistent with Bayes' rule.

Date received: May 21, 2000

Copyright © 2000 by the author(s). The author(s) of this document and the organizers of the conference have granted their consent to include this abstract in Atlas Mathematical Conference Abstracts. Document # cafc-59.