WHY ISSUE TRACKING STOCK? INSIGHTS FROM A COMPARISON WITH SPIN‐OFFS AND CARVE‐OUTS

In recent years, tracking stocks, which amount to a new form of corporate restructuring, have been gaining in popularity. In 1999 alone, 17 companies announced new tracking stock issues, and by February 2000 there were 40 tracking stocks trading in the U.S. equity markets. Why have tracking stocks become so popular in recent years? In this article, the authors present new evidence on the effectiveness of tracking stock issues in creating shareholder value as compared to the record of two other closely related forms of corporate restructuring—spin‐offs and equity carve‐outs. The authors find that the parents and subsidiaries of tracking‐stock firms are more “related” than those that undertake the other two forms of corporate restructuring, that there is a positive announcement effect (similar in size to that of spin‐offs but greater than that of equity carve‐outs) on stock prices, and that the number of analysts following the firm increases following the issuance of tracking stock. These findings are interpreted as suggesting that the main corporate motives for issuing tracking stock are the valuation benefits from providing investors with more information about the newly listed subsidiary, while at the same time preserving the existing synergies between the business units involved. This maintenance of existing synergies, however, appears to have come at a significant price. Under the tracking stock structure, there seem to be no benefits attributable, as in the case of spin‐offs, to improvements in corporate governance. While spinoffs significantly increase the probability that the parents or subsidiaries will later be taken over (with its disciplining effect on management), there is no such increase in takeover probability for firms issuing tracking stock. Consistent with this difference, the authors find that the market‐adjusted two‐year holding period return for tracking stock parents and subsidiaries is significantly lower than the corresponding return for spinoffs and their corporate parents.     

Family control and dilution in mergers

We analyze the influence of the level as well as the change in family ownership on value creation in mergers involving newly public firms. Our findings suggest that acquirers with low levels of family ownership earn lower abnormal returns than do those with high levels of ownership. In addition, families with low ownership in their firm are more likely to use cash as the medium of exchange, thus avoiding dilution and maintaining their control. Further, acquisitions of targets with low levels of family ownership are associated with greater value creation. Our results are consistent with the entrenchment of families at low levels of ownership and a better alignment of their interests with those of minority shareholders at high levels of ownership. Finally, we find that dilution of the family’s ownership, due to the use of stock as the medium of exchange, alters the family’s incentives and thus influences firm value.     

Do Large Blockholders Reduce Risk?

The conventional assumption in the asset pricing literature is that the identity of a company's owners is largely irrelevant, but studies of companies with “blockholders”—shareholders with large positions in a particular company—provide grounds for questioning this assumption. Unlike the well‐diversified investors of modern portfolio theory, blockholders have strong incentives to monitor corporate performance and, when necessary, to exert control over ineffective managements and boards. The findings of many studies support the idea that blockholders have a positive effect on rates of return. The authors of this article report the findings of their recent investigation of whether blockholders might also have a positive effect on shareholder value by reducing the risk of the companies in which their holdings are concentrated. After distinguishing between companies with individual as opposed to corporate blockholders, and those with one share, one vote as opposed to those with dual‐class shares, the authors find that ownership of large positions by individuals—but not corporations—was associated with lower systematic risk (when using both Fama‐French multiple factor and CAPM models). At the same time, they find that the firm‐specific risk of such companies was higher, but “biased” toward positive outcomes—that is, smaller downsides with larger upsides. What's more, this upward shift in performance and risk‐profile was achieved at least partly through increases in productivity as reflected in higher profit margins, profitability, profit per employee, and operating leverage, and lower costs of goods sold, SGA, and cash holdings. By contrast, in the case of blockholders in companies with dual‐class share structures, all of these positive associations with blockholders were either significantly weaker, or reversed. That is, whereas the presence of individual blockholders appears to increase productivity and value under a one share, one vote governance regime, blockholders in companies with dual‐class structures were associated with higher systematic risk and reduced productivity and value.     

Management Quality and Equity Issue Characteristics: A Comparison of SEOs and IPOs

We use hand-collected data on the management quality of firms making seasoned equity offerings (SEOs) or initial public offerings (IPOs) to analyze the relationship between management quality and equity issue characteristics, and to compare the effect of management quality on SEOs versus IPOs. We hypothesize that higher quality managers are more credible to equity market investors, thereby reducing the information asymmetry they face in the market and outsiders’ information production costs. Therefore, the equity issues of higher management quality firms will have more reputable underwriters, smaller underwriting spreads, and other expenses, and smaller SEO discounts. Further, since better managers will be able to select better projects, higher management quality firms will have larger offer sizes. Finally, since SEO firms are likely to suffer from less information asymmetry compared to IPO firms, these effects will be smaller for SEOs than for IPOs. Our findings support the above hypotheses. Our direct tests of the relationship between management quality and information asymmetry, and our comparison of information asymmetry in SEOs versus IPOs provide further support for these hypotheses.     

The medium of exchange in acquisitions: Does the private information of both acquirer and target matter?

We present a direct test of the choice of the medium of exchange in acquisitions when both acquirers and targets possess private information about their own intrinsic values. We test three hypotheses: first, whether acquirers are more likely to choose a stock offer as their equity is more overvalued; second, whether acquirers facing a greater extent of information asymmetry in evaluating targets are more (or less) likely to use a stock versus a cash offer; and third, whether a cash offer deters competing bids. Our findings are as follows. First, acquirers choosing a stock offer are overvalued and those choosing a cash offer are correctly valued. Second, the greater the extent of acquirer overvaluation, the greater the likelihood of it using a stock offer; further, the greater the extent of information asymmetry faced by an acquirer in evaluating its target, the greater its likelihood of using a cash offer. Third, the extent of an acquirer's under- or overvaluation significantly affects the abnormal returns to its equity upon the acquisition announcement. Finally, the use of cash by an acquirer deters competing bids. We conclude that private information held by both acquirers and targets together determine the medium of exchange.