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This article examines the pricing of stock for 251 equity carve-outs during the 1986-1995 period. We document a mean initial-day return of 5.83% and a mean one-week return of 5.43%. Among carve-outs, the initial underpricing is lower for issues represented by high prestige investment bankers and those that have a lower offer price. In comparison with 251 initial public offering (1PO) firms matched by size and book-to-market ratio of equity, carveouts exhibit significantly lower initial-day returns, but their buy-and-hold returns for sixmonth and one-year periods are not significantly different from IPOs. The IPO firms have a three-year return of 28.82% which is significantly higher than the 21.07% return for the carve-out firms. seminar participants at the 1999 FMA Annual Meeting. We would like to acknowledge a grant from Suffolk University towards the research project. 123 124 A. Prezas, M. Tarimcilar and G. Vasudevan/The Financial Review 35 (2000) [123][124][125][126][127][128][129][130][131][132][133][134][135][136][137][138] initial public offering in the traditional sense but is commonly referred to as an "equity carve-out." In an equity carve-out, a portion of a wholly owned subsidiary is sold to the public with the parent company retaining substantial ownership. Equity carve-outs increasingly have become a common way for companies to divest their subsidiaries.' A number of explanations for carve-outs have been discussed in finance and economics literature and the popular press. One explanation is that carve-outs help to improve performance because managers focus on their core lines of business (John and Ofek, 1995; Comment and Jarrell, 1995). Carve-outs, like spin-offs and targeted stock offerings, also have been used to improve the information available to investors (Gilson, Healy, Noe, and Palepu, 1997). Inspite of their increasing importance, not much evidence is available on the pricing of equity carveouts. Our study provides evidence on the initial-day pricing and on the long-run stock price performance of equity carve-outs. It also examines the relation between investment banker reputation and the pricing of these carve-outs.Several studies have found that firms conducting IPOs have high initial-day returns and poor post-issue stock price performance (e.g. Ritter, 1991; Loughran and Ritter, 1995). Theoretical explanations of this phenomenon hinge on informational asymmetries between different market participants. Rock (1986) suggests that underpricing helps keep in the market the uninformed investors who on average end up with the low quality IPOs. Welch (1989) indicates that underpricing enables firms to signal their high quality and come back to the market when they need to issue new securities. Carter and Manaster (1990) show that firms can reduce the underpricing by choosing a more prestigious underwriter. Indeed, studies find that initial public offerings conducted by high prestige investment bankers have lower initial-day returns and superior post-issue stock price performance.Since market p...

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