Spinoff versus Sell-Off Decision
There are multiple options when one company decides to separate a business from the entire corporation. These may include a divestiture or sell-off, an outright sale of the unit, or a spinoff.
Companies with overvalued assets based on their intrinsic value usually sell off the business to maintain value. This is based on an analysis by Prezas and Simonyan, where they examined 4200 sell-offs and 378 spinoffs from 1980–2011.
On the other hand, companies tend to choose spinoffs when they have lower valuations. This is also the best decision when investors have too many demands. These demands can be too strong that it can result in improved values for shareholders of the entity. Another finding is that spinoffs produce higher values even though divestitures can also produce great wealth.
Spinoffs and Bondholder Wealth
Despite the positive shareholder effects, spinoffs make us question if these responses come at the expense of bondholders. In early studies, there was not enough proof of wealth transfers.
However, a new study by Maxwell and Rao found a negative return on bondholders. After analyzing the bond market responses in 80 spinoffs from 1976–1997, they reached this conclusion.
They also considered the loss of collateral value, as well as bankruptcy protection from the spinoff vital in the outcome. This is buttressed by their conclusion that organizations would have their bond rating minimized in the period of the spinoff.
This loss of bondholders is different from the gain of shareholders and an increase in the firm value. The average gain for shareholders is 2.9%, while the firm value increases at about 1.6%. However, this positive return is only an aspect of the bondholders’ wealth transfer.
Wealth Effects of Spinoffs on Shareholders
This section discusses the impacts of spinoffs on shareholders through different lenses.
The US vs. Europe
Most studies about sell-offs and spinoffs highlight US companies. But in Europe, spinoffs are usually caused by “governance earthquakes.” According to Boreiko and Murgia, governance adjustments include the designation of a new CEO or a danger of a takeover This is based on an evaluation of 97 European spinoffs.
According to Shimizu and Hitt, the appointment of a new CEO triggers divestitures. This study is based on their evaluation of US divestitures. In England, corporate spinoffs are more likely to happen than in any other part of Europe. In Europe, the typical ownership structure is more concentrated rather than in England or the US. This puts mainland European shareholders in a less compelling position than their British partners. This does not apply to those large controlling equity holders that are related to family.
Boreiko and Murgia’s sample of European spinoffs presented positive shareholder impacts. Their results also support findings in the US, where they found a 5.7% effect in focus-enhancing spinoffs than for non–focus-enhancing deals (3.3%).
Nonetheless, there was no advancement in terms of operating performance at parent companies after the spinoff. They only found this effect on the spun-off firm. The improved entity that was spun off did not convince the parent to be more focused. Conventionally, they internally grow it. This contradicts the research on US spinoffs, which revealed improvements in performance for focus-enhancing deals.
Wealth Effects of Voluntary Defensive Sell-Offs
When they use voluntary sell-offs as a defense against takeovers, there may be no positive wealth effects. While researchers Loh, Bezjak, and Toms found positive wealth effects on shareholders, there is no positive effect when companies use sell-offs as an antitakeover defense.
The researchers used 59 firms from 1980 to 1987, where 13 were speculated targets of the takeover. They found a 1.5% increase means an aberrant return over a one-day duration until the sell-off date.
But when two samples were created from the division of the sample, the 13 targets didn’t show changes in wealth. This implies that the market treats purchases differently without considering a positive change when firms engage in sell-offs as an antitakeover strategy.
Involuntary Sell-Offs’ Wealth Effects
Most pieces of literature regarding the sell-offs’ effects on stockholder wealth show the wealth increase of the parent company stockholders. They also show that the market efficiently looks forward to the event. This means the stock price reaction happens before the actual sell-off date. The effect of a parent company forced to divest a profitable portion is different from that of an unwanted subsidiary.
For example, Santa Fe-Southern Pacific received its ominous decision requiring it to strip itself of the Southern Pacific Railway. The stock price declined and a takeover target occurred
Another study in 1981 by Kudla and McInish tried to find out the effects of Louisana-Pacific Corporation’s forced spinoff by the parent company, Georgia-Pacific. The FTC enforced these.
It found that the securing of 16 organizations in the southern United States would bring about an anticompetitive focus in the pressed wood industry. It represented an aggregate of 673,000 sections of land of pine trees. The researchers also found that Georgia-Pacific’s stock price had been declining before the FTC complaint through cumulative residuals. These residuals adjust for market effects. In 1972, the company spun off and the stock price rebounded. Despite this, the cumulative residuals were not able to recover completely from 1971 to March 1974
According to Miles and Rosenfeld, the wealth of bondholders minimized after the spinoff while stockholders’ increased. One vital aspect here may be the lower cash flows after the spinoff, as well as the risk of bondholders.
Kudla and McInish Study
Kudla and McInish measured these risks in the context of Louisiana-Pacific’s involuntary spinoff. They tried to analyze the betas of the company before and after the spinoff.
The betas reflect any change in the systematic or undiversifiable risk The scholars also concluded that there’s a large statistically significant increase in the betas of the company post-spinoff. The increase of the perception of the market that Georgia-Pacific made decreased monopoly power after the spinoff caused this. This then caused the firm to carry more risks.
This may imply that a forced divestiture mandate made by the government will have an adverse impact on the stock price of the divesting firm. For instance, Ellert reviewed 205 defendants in antitrust merger lawsuits. He found a 21.86% decline in the equity value during the month the complaints were filed. The timing of the effect as well as the reversal of the declining trend is addressed by Kudla and MicInish.
There must be an increase in the value of the firm’s competitors’ equity if antitrust enforcement is effective in reducing the monopoly of the selling firm. However, the authorities have little help for their activities in the stock prices of the stripping firms’ contenders. There was no significant response by the value of the competitors’ equity to mandated sell-offs done.