1. Spin-Offs n 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. n Two separate companies after the spin- off. n No cash inflow to the firm from the spin- off. (Subsidiary is not being sold.)

2. Reasons for Spin-Offs n Improved focus and reduction of negative synergies. Daley, et al (1997) n Improved investment efficiency. Diversified firms allocate investment funds inefficiently. Ahn-Denis (2004). n Reduction of information asymmetry. Krishnaswami-S(1999). n Ability to offer more effective incentive contracts to managers. n Tax and regulatory-related reasons. n Wealth transfer from bondholders. (Marriott)

3. Reasons for Spin-Offs (KS): Reduction of information asymmetry. Krishnaswami-Subramaniam (1999) (KS) n “… 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. n “… independently traded shares of engineering unit would produce a higher overall valuation for Raytheon.” Dennis Picard, CEO of Raytheon, WSJ March 6, 1995. n “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 nuclear- waste dump.” Business Week, Nov 25, 1996, p 38, article on Westinghouse spin-off.

4. Reasons for Spin-Offs (KS): Reduction of information asymmetry. Krishnaswami-Subramaniam (1999) (KS) n In a spin-off no cash inflow to the firm. n If a subsidiary (hence, the company) is undervalued, spin-off is appropriate since subsidiary is not being sold.

5. 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.

6. 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).

7. 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 cross- industry 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: Improved focus and reduction of negative synergies. Daley, et al (1997)

8. 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)

9. 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)

10. 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. Reasons for Spin-Offs: Improving investment efficiency. Diversified firms allocate investments inefficiently. Ahn-Denis (2004)

11. Berger-Ofek (1999) n Diversification is inefficient relative to a more focused strategy [Bhagat, Shleifer and Vishny (1990), Lang and Stulz (1994), Comment and Jarrell (1995)]. n What might be the role of market disciplinary forces, and internal governance mechanisms in spurring divestitures ? Table 3.

12. Herfindahl Index (H) n H = (Sum of sales-squared of all divisions) / (Square of sum of the sales of all divisions) n Closer H is to one, more the firm’s sales are concentrated within a few divisions. n Example n Firm A: 2 divisions, sales of $10 million each. H A =(100 + 100)/400 =.5 n Firm B: 2 divisions, sales of $18 million and $2 million. H B = (324 + 4)/400 =.82

13. Berger-Ofek (1999) Appendix B n Return: Stock market’s response to announcements related to refocusing activities. n Example: Allegheny International: 45.2% (wow!) n Most returns are positive. n Returns are most positive for refocusing done in response to financial distress (Table 9).