Spin-Offs
Spinoff: A firm creates a subsidiary to
hold a portion of its assets, distributes
shares of its subsidiary to its
shareholders to create an independent
company.
 Two separate companies after the spinoff.
 No cash inflow to the firm from the spinoff. (Subsidiary is not being sold.)

Reasons for Spin-Offs

Improved focus and reduction of negative synergies.
Daley, et al (1997)


Improved investment efficiency. Diversified firms
allocate investment funds inefficiently. Ahn-Denis (2004).
Reduction of information asymmetry.
Krishnaswami-S(1999).



Ability to offer more effective incentive contracts to
managers.
Tax and regulatory-related reasons.
Wealth transfer from bondholders. (Marriott)
Reasons for Spin-Offs (KS): Reduction of information
asymmetry. Krishnaswami-Subramaniam (1999) (KS)



“… the market value of AT&T was being buried. Investors
couldn’t understand the strategy of the combined firm” After the
spin-off, AT&T would be the biggest pure play in
telecommunications. “Investors will clearly understand it now.”
Robert Allen, then-Chairman of AT&T, WSJ Sep 21, 1995.
“… independently traded shares of engineering unit would
produce a higher overall valuation for Raytheon.” Dennis Picard,
CEO of Raytheon, WSJ March 6, 1995.
“Wall Street couldn’t figure out how to value a $9.5 billion
company with one foot in a TV studio and other in a nuclearwaste dump.” Business Week, Nov 25, 1996, p 38, article on
Westinghouse spin-off.
Reasons for Spin-Offs (KS): Reduction of information
asymmetry. Krishnaswami-Subramaniam (1999) (KS)
In a spin-off no cash inflow to the firm.
 If a subsidiary (hence, the company) is
undervalued, spin-off is appropriate
since subsidiary is not being sold.

Reasons for Spin-Offs (KS):Measures of Information
Asymmetry
• Error in analysts’ forecasts of earnings.
•Absolute value of [(Forecast EPS - Actual EPS)/Share
Price]
• Standard deviation of analysts’ forecasts of earnings.
• Normalized forecast error.
•(Error in analysts’ forecasts of earnings / Earnings
volatility of firm)
• Standard deviation of (market-adjusted) stock returns
around earnings announcements.
•Volatility of ( market-adjusted) daily stock returns.
Reasons for Spin-Offs (KS): Main Findings (Table 5)
• Firms that engage in spin-offs have higher levels of
information asymmetry about their value than other
comparable firms.
• Firms that engage in spin-offs have higher levels of
information asymmetry about their value before the spin-off
compared to after the spin-off.
• Firms with more growth opportunities and less internally
generated capital are more likely to engage in spin-off,
perhaps to mitigate information asymmetry problems
before approaching the capital markets (Table 10).
•Firms engaging in spin-offs raise capital more often and in
greater amounts after the spin-off (Table 9).
Reasons for Spin-Offs: Improved focus and reduction of
negative synergies. Daley, et al (1997)
• Cross-industry spin-off: Spun-off unit operates in a
different industry than core line of business for pre-spinoff
company.
•Same-industry spin-off: Spun-off unit operates in same
industry as the core line of business for pre-spinoff
company.
•More value created in cross-industry spin-offs.
•(Table 2) Stock market reaction more positive for crossindustry spin-offs.
•(Table 3) Return on assets (operating income/total
assets) (ROA) increases after spin-off in cross-industry
spin-offs.
•(Table 6) ROA of parent improves but not of the
spun-off unit!
Reasons for Spin-Offs: Improving investment efficiency.
Diversified firms allocate investments inefficiently.
Ahn-Denis (2004)
Page 496:
Excess value = (Market-to-sales of diversified company)
minus (Weighted average of market-to-sales of single-unit
companies)
Table 3:
Pre-spinoff : Negative excess value.
Post-spinoff: Zero excess value.
Reasons for Spin-Offs: Improving investment efficiency.
Diversified firms allocate investments inefficiently.
Ahn-Denis (2004)
How do we measure investment effectiveness?
NPV rule: Invest if NPV > 0.
[NPV = PV of inflows – PV of outflows]
Tobin’s q = Market value of assets / replacement cost of
assets. Invest if q>1.
q>1 : NPV>0
q<1 : NPV<0
Reasons for Spin-Offs: Improving investment efficiency.
Diversified firms allocate investments inefficiently.
Ahn-Denis (2004)
Table 4, Panel C: Capital expenditure/Sales
•Higher Capital expenditure/Sales post-spinoff compared to
pre-spinofff.
•Much higher Capital expenditure/Sales post-spinoff for
high-q divisions.
•No difference Capital expenditure/Sales for low-q
divisions.
Table 7: Positive correlation between change in excess
value and change in investment efficiency.
Berger-Ofek (1999)

Diversification is inefficient relative to a
more focused strategy [Bhagat, Shleifer and
Vishny (1990), Lang and Stulz (1994), Comment and Jarrell
(1995)].

What might be the role of market
disciplinary forces, and internal
governance mechanisms in spurring
divestitures ? Table 3.
Herfindahl Index (H)



H = (Sum of sales-squared of all divisions) /
(Square of sum of the sales of all divisions)
Closer H is to one, more the firm’s sales are
concentrated within a few divisions.
Example
 Firm A: 2 divisions, sales of $10 million
each. HA =(100 + 100)/400 = .5
 Firm B: 2 divisions, sales of $18 million and
$2 million. HB = (324 + 4)/400 =.82
Berger-Ofek (1999) Appendix B

Return: Stock market’s response to
announcements related to refocusing
activities.

Example: Allegheny International: 45.2% (wow!)
Most returns are positive.
 Returns are most positive for refocusing
done in response to financial distress
(Table 9).
