Internal capital markets and investment policy: evidence from corporate spinoffs

Abstract

We analyze changes in investment policy following 106 spinoffs between 1981 and 1996. Pre-spinoff, the sample firms are valued at a discount and invest less in their high q segments than do their single-segment peers. Post-spinoff, there is a significant increase in measures of investment efficiency and the diversification discount is eliminated. Furthermore, changes in excess value around the spinoff are positively related to changes in measures of investment efficiency. These findings support the view that (i) diversified firms allocate investment funds inefficiently, and (ii) by breaking up the conglomerate, spinoffs create value by improving investment efficiency. r

The Dynamics of Diversification Discount*

“…Consistent with this view, Ahn and Denis (2004) find that the value loss from diversification is completely restored through spinoffs. These studies imply that diversification is a costless trial, as failure from diversification could be reimbursed through refocusing.…”

“…Over the entire sample period, 6) I also use industry sales (or, assets) weighted mean instead of industry median to compute excess value. Similar to Ahn and Denis (2004), Berge and Ofek (1995), and Rajan et al (2000), the results are robust to the various methods used to compute excess values.…”

“…3) Refocusing literature including Ahn and Denis (2004), Gertner, Powers, Scharfstein (2002), and Dittmar and Shivdasani (2000) also document that diversified firms are valued less than focused firms and refocusing is value enhancing through the elimination of inefficiency present in diversification.…”

Are Corporate Spin-Offs Prone to Insider Trading?

“…(See, among others, Hite and Owers (1983) and Schipper and Smith (1983)). Ahn and Denis (2004) rationalize such positive excess returns through the subsequent enhanced investment efficiency of the parent, while John and Ofek (1995) rationalize it through an improvement in operating performance. Maxwell and Rao (2003) argue that they reflect a wealth transfer from bondholders to shareholders (see also Veld and Veld-Merkoulova (2008)), while Gertner, Powers, and Scharfstein (2002) suggest an improved allocation of capital.…”

“…1 While there is recent empirical evidence of informed trading ahead of corporate announcements such as earnings announcements (Kaniel, Liu, Saar, and Titman (2012), Kadan, Michaely, and Moulton (2014), Goyenko, Ornthanalai, and Tang (2014)), mergers and acquisitions (M&A) (Cao, Chen, and Griffin (2005), Chan, Ge, and Lin (2014), Augustin, Brenner, and Subrahmanyam (2014)), and bankruptcies (Ge, Humphrey-Jenner, and Lin (2014)), no such evidence exists for the period preceding corporate spinoff (SP) announcements, which pertain to the sale of a subsidiary or a division of a company as a separate entity. This is surprising since SPs are supposed to be publicly unexpected, and largely unpredictable, and the parent firm's stock price typically rises after the deal announcement (Maxwell and Rao (2003), Ahn and Denis (2004)). 2 In other words, the benefit of private information is clearly economically significant before SP announcements, although an insider would be less certain of the outcome compared to an insider with information on a M&A announcement.…”