Success Factors of Corporate Spin-Off Transactions: Empirical Study
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INTRODUCTION 8
CHAPTER 1. CORPORATE SPIN-OFF MECHANISM AND MOTIVATION 11
1.1. The concept and types of spin-offs 12
1.2. Reasons of conducting a corporate spin-off 17
1.3. Hypotheses formulation 25
CHAPTER 2. EMPIRICAL ANALYSIS OF A SPIN-OFF PERFORMANCE AND CAUSAL FACTORS 29
2.1. Research design 29
2.2. Results and discussion 35
CONCLUSION 42
LITERATURE 44
APPENDIX 1. List of spin-off transactions 48
CHAPTER 1. CORPORATE SPIN-OFF MECHANISM AND MOTIVATION 11
1.1. The concept and types of spin-offs 12
1.2. Reasons of conducting a corporate spin-off 17
1.3. Hypotheses formulation 25
CHAPTER 2. EMPIRICAL ANALYSIS OF A SPIN-OFF PERFORMANCE AND CAUSAL FACTORS 29
2.1. Research design 29
2.2. Results and discussion 35
CONCLUSION 42
LITERATURE 44
APPENDIX 1. List of spin-off transactions 48
The world economy’s globalization leads to growth of the businesses and increase in scope of activities. It directly leads to complication of the company’s structure and all of the mechanisms in company management. For the company to save development rates and to avoid stagnation it can be crucial to divide a business of the initial company (so-called parent company) into two or more different entities. While it is usually hard to sell-off an unrelated subsidiary for a fair price, businesses still have option to separate some part of the company as an independent business, saving assets with shareholders. Such event is called a spin-off. Company can spin-off unrelated subsidiaries in order to concentrate attention on main business direction or sell it to other company later.
While an opportunity to sell a part of the business sounds good to concentrate sources on main activity, in real life this option is not always the easiest case. The most popular decision in a modern world is conducting a Merger and Acquisition (M&A) transaction. But in case of selling just a part of a business the main company should firstly spin-off it’s subsidiary. It leads to highly complex structure of two consistent operations. It takes a lot of time, which may change the market situation and destroy plans of M&A. And even if long-term orientation is not the case of a failure, there is still evidence that less than a quarter of M&A transactions end-up successfully.
Another option is a sell-off of a part of the company. In such case a subsidiary is acquired directly by other company from the market and shareholders get the payment according to the evaluation of this part of the particular subsidiary. But it would leave shareholders without an opportunity to extract potential value from the subsidiary in case when owners’ expectations are higher than market evaluation of the new entity. In such case shareholders would prefer to save control not only under the parent company, but also under a new firm, which is called a spun-off firm.
So, there are many cases when the best option is to divide a part of the company into a new firm, while saving ownership of previous shareholders and connections with the initial company. It is the case when a spin-off occurs: a company distributes all of the common shares it owns in a controlled subsidiary to its existing shareholders, thereby creating a separate company. Number of corporate spin-offs rises last years with a decline of up-to-date studies on this topic. It is paradoxically due to absence of academic researchers, which could support management’s decision-making on the verge of choosing an appropriate divestiture operation.
There is a strong pressure on big conglomerate companies to simplify corporate structure. According to Bocconi students investment club (2021) underestimation of such companies can be up to 15%. It pushes business to get rid of such discounts from unproper management of unrelated subsidiaries. Deloitte (2023) assume that around 48% of respondent companies are going to conduct a divestiture during the next year. While, around 14% of such transactions are expected to be spin-offs. It brings evidence of a strong relevance of corporate spin-offs in a modern world economy.
While the fraction of highly diversified firms has a tendency to decline by time, leading to simplification of structure and decrease of conglomerate companies, the number of academic papers in the field of a spin-off is still insufficient to support management decision-making process in such a controversial situation of company’s development. For shareholders and management, the reason in a spin-off is in an increase of total companies’ market capitalization of two new companies comparing with the price of parent company alone with a non-public division. Usually, spin-off announcements are supported with value increase due to potential performance improvement and an increase in corporate focus.
While an increase in shareholder’s value should be grounded with concrete expectations, still there is space in studies concerning reasons, influencing a spin-off performance. The evidence of spin-off as a driver to increase company’s value was studied by Kim (2023), Smolnik (2021), Steurer (2021), Veld (2009), Chai (2018). While, a research gap is that researches don’t take all of the factors in one model, examining effect of indicators separately. In the result, interdependence of potential performance indicators can’t be analyzed as a complex model.
The research problem is to analyze the relationship between spin-off performance and characteristics of a spin-off, such as parent company’s features, type of a spin-off and spun-off connections with parent company.
The following research questions are stated:
• What is the influence of a spin-off announcement on a stock price?
• Which factors of the company or a spin-off can affect spin-off’s success and how?
The goal of the research is to identify factors influencing a spin-off success and explore their relationship with a spin-off performance. To achieve the goal the following objectives were stated:
• Review the literature on the topic of corporate spin-off performance to analyze the concept of a spin-off and to find potential indicators, which can influence a spin-off performance;
• Conduct an empirical analysis to identify effect of factors, influencing a spin-off performance;
• сFormulate recommendations for management and draw theoretical implication.
While an opportunity to sell a part of the business sounds good to concentrate sources on main activity, in real life this option is not always the easiest case. The most popular decision in a modern world is conducting a Merger and Acquisition (M&A) transaction. But in case of selling just a part of a business the main company should firstly spin-off it’s subsidiary. It leads to highly complex structure of two consistent operations. It takes a lot of time, which may change the market situation and destroy plans of M&A. And even if long-term orientation is not the case of a failure, there is still evidence that less than a quarter of M&A transactions end-up successfully.
Another option is a sell-off of a part of the company. In such case a subsidiary is acquired directly by other company from the market and shareholders get the payment according to the evaluation of this part of the particular subsidiary. But it would leave shareholders without an opportunity to extract potential value from the subsidiary in case when owners’ expectations are higher than market evaluation of the new entity. In such case shareholders would prefer to save control not only under the parent company, but also under a new firm, which is called a spun-off firm.
So, there are many cases when the best option is to divide a part of the company into a new firm, while saving ownership of previous shareholders and connections with the initial company. It is the case when a spin-off occurs: a company distributes all of the common shares it owns in a controlled subsidiary to its existing shareholders, thereby creating a separate company. Number of corporate spin-offs rises last years with a decline of up-to-date studies on this topic. It is paradoxically due to absence of academic researchers, which could support management’s decision-making on the verge of choosing an appropriate divestiture operation.
There is a strong pressure on big conglomerate companies to simplify corporate structure. According to Bocconi students investment club (2021) underestimation of such companies can be up to 15%. It pushes business to get rid of such discounts from unproper management of unrelated subsidiaries. Deloitte (2023) assume that around 48% of respondent companies are going to conduct a divestiture during the next year. While, around 14% of such transactions are expected to be spin-offs. It brings evidence of a strong relevance of corporate spin-offs in a modern world economy.
While the fraction of highly diversified firms has a tendency to decline by time, leading to simplification of structure and decrease of conglomerate companies, the number of academic papers in the field of a spin-off is still insufficient to support management decision-making process in such a controversial situation of company’s development. For shareholders and management, the reason in a spin-off is in an increase of total companies’ market capitalization of two new companies comparing with the price of parent company alone with a non-public division. Usually, spin-off announcements are supported with value increase due to potential performance improvement and an increase in corporate focus.
While an increase in shareholder’s value should be grounded with concrete expectations, still there is space in studies concerning reasons, influencing a spin-off performance. The evidence of spin-off as a driver to increase company’s value was studied by Kim (2023), Smolnik (2021), Steurer (2021), Veld (2009), Chai (2018). While, a research gap is that researches don’t take all of the factors in one model, examining effect of indicators separately. In the result, interdependence of potential performance indicators can’t be analyzed as a complex model.
The research problem is to analyze the relationship between spin-off performance and characteristics of a spin-off, such as parent company’s features, type of a spin-off and spun-off connections with parent company.
The following research questions are stated:
• What is the influence of a spin-off announcement on a stock price?
• Which factors of the company or a spin-off can affect spin-off’s success and how?
The goal of the research is to identify factors influencing a spin-off success and explore their relationship with a spin-off performance. To achieve the goal the following objectives were stated:
• Review the literature on the topic of corporate spin-off performance to analyze the concept of a spin-off and to find potential indicators, which can influence a spin-off performance;
• Conduct an empirical analysis to identify effect of factors, influencing a spin-off performance;
• сFormulate recommendations for management and draw theoretical implication.
The aim of this research was to analyze the relationship between spin-off performance and characteristics of a spin-off, such as parent company’s features, type of spin-off and spun-off connections with parent company. To achieve it, the literature review on topic of corporate spin-off was conducted. It briefly describes topic relevance and the need of such research in a modern world. Then the concept of a spin-off in several contexts was described, bringing examples of different types of spin-offs and the differentiation among other types of transactions. It brought the paper to formulation of the definition of a spin-off relevance for the research objectives. Next, possible reasons and motives of conducting a spin-off were described, explaining the need of such type of transaction and company's expectations. Two examples of a successful and a failure spin-offs within the future sample were analyzed to get a deeper understanding of future empirical results. Finally, the evidence of value created by a spin-off was provided and an appropriate measure of a spin-off performance was chosen. Hypotheses for regression part of the empirical study were drawn.
Within empirical analysis, the average influence of a spin-off announcement on a stock price was founded as 1.81% of abnormal return for the final sample, being significant on a 1% significance level. The final sample consisted of 106 spin-off observations from 2015 to 2023 years. Potential factors influencing a spin-off performance from the literature review were analyzed within a regression model with cumulative abnormal return of event study part as a dependent variable of a corporate spin-off performance. Independent variables were taken in accordance with hypotheses formulated in the final of literature review. The variables were described with measurements. In the final statistically significant model proposed hypotheses were accepted or rejected. The effect and significance of these factors were analyzed, bringing insights of factors affecting a transaction potential success. The positive relationship was founded between spin-off performance and next features: cross industry origin of a spun-off entity, transaction size and retention of connections with parent company through board of director’s transfer. Hypotheses regarding company's size and leverage ratio's effect were rejected.
Theoretical contribution was drawn and a managerial implication was proposed. Based on the results, it is recommended to spin-off subsidiaries operating in an industry other than the parent company's industry; to conduct spin-offs in cases, when the subsidiary occupies a significant amount of the company; and to send directors from the parent board to a new company's board of directors. It draws a perspective of the need in a spin-off, when a cross-industry subsidiary become too big and describes a proper way to conduct such a transaction - to save connections of the new company with the parent by the board of directors’ retention. It will save the supervision under the new company, needed to operate well especially in the first years after the separation.
Board of directors should take into account these recommendations to identify the need in a spin-off before it will destroy a lot of company’s value for shareholders. Top management of the company can use study results in the process of planning such a transaction to conduct a spin-off in a most profitable way. Based on the study findings, the highest level of decision-making in big companies can now ground it’s plans on empirical statistically significant results of this paper.
Within empirical analysis, the average influence of a spin-off announcement on a stock price was founded as 1.81% of abnormal return for the final sample, being significant on a 1% significance level. The final sample consisted of 106 spin-off observations from 2015 to 2023 years. Potential factors influencing a spin-off performance from the literature review were analyzed within a regression model with cumulative abnormal return of event study part as a dependent variable of a corporate spin-off performance. Independent variables were taken in accordance with hypotheses formulated in the final of literature review. The variables were described with measurements. In the final statistically significant model proposed hypotheses were accepted or rejected. The effect and significance of these factors were analyzed, bringing insights of factors affecting a transaction potential success. The positive relationship was founded between spin-off performance and next features: cross industry origin of a spun-off entity, transaction size and retention of connections with parent company through board of director’s transfer. Hypotheses regarding company's size and leverage ratio's effect were rejected.
Theoretical contribution was drawn and a managerial implication was proposed. Based on the results, it is recommended to spin-off subsidiaries operating in an industry other than the parent company's industry; to conduct spin-offs in cases, when the subsidiary occupies a significant amount of the company; and to send directors from the parent board to a new company's board of directors. It draws a perspective of the need in a spin-off, when a cross-industry subsidiary become too big and describes a proper way to conduct such a transaction - to save connections of the new company with the parent by the board of directors’ retention. It will save the supervision under the new company, needed to operate well especially in the first years after the separation.
Board of directors should take into account these recommendations to identify the need in a spin-off before it will destroy a lot of company’s value for shareholders. Top management of the company can use study results in the process of planning such a transaction to conduct a spin-off in a most profitable way. Based on the study findings, the highest level of decision-making in big companies can now ground it’s plans on empirical statistically significant results of this paper.
