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Contribution Details

Type Master's Thesis
Scope Discipline-based scholarship
Title Corporate spin-offs: Abnormal stock returns and operating performance improvements
Organization Unit
Authors
  • Cédric Lang
Supervisors
  • Andrin Thomas Bögli
  • Alexander Wagner
Language
  • English
Institution University of Zurich
Faculty Faculty of Economics, Business Administration and Information Technology
Number of Pages 53
Date 2015
Abstract Text Executive Summary Problem definition Spin-offs or demergers are a special kind of divestment. By distributing shares of a subsidiary to the shareholders a new stand-alone company is created and the former parent company continues to operate as a restructured entity. Previous research shows that the announcement of spin-offs yields positive abnormal stock returns (Veld and Veld-Merkoulova (2009)). There are various theories to explain these positive value effect as the increase in corporate focus, higher takeover probability or the mitigation of information asymmetries. Due to the elimination of negative synergies such as inefficient organisational structures or a lack of strategic fit between the parent company and its subsidiary spin-offs shall increase the competitiveness of both companies, leading to operating improvements and increases in shareholder value (Desai and Jain (1999)). Furthermore, the creation of two more focussed stocks enhances transparency for market participants and allows to acquire the companies separately instead of buying the combined firm (Krishnaswami and Subramaniam (1999)). These explanations about positive aspects of spin-offs are only a short excerpt of previously analysed theories for value generation by the transaction. Various other aspects are found that at least partially explain positive shareholder value effects. As these theories vary widely across different fields and are basically not mutually exclusive, value generation seems to be attributable to a mixture of several aspects. Nevertheless, while explanations for shareholder gains differ substantially, there is a general consensus that positive abnormal stock returns around spin-off announcements do occur. Investors incorporate expected future benefits arising from the transaction as soon as the transaction intention gets published. Positive abnormal returns have been documented for US, European and Asian stock markets (Veld and Veld-Merkoulova (2009)). In contrast to the short-term announcement performance, previous literature provides mixed evidence about how companies involved in spin-offs perform in the long-term after the completion of the transaction. Analyses of US samples indicate that spin-offs do not only generate abnormal returns at the announcement, but also post-transaction. Superior performance is documented for periods of up to three years after spin-off completion for parents, subsidiaries and pro-forma combinations of the two companies (Cusatis, Miles, and Woolridge (1993) and Desai and Jain (1999)). Therefore, investors underestimate the total value generation by the transactions at the announcements, which consequently leads to further gains in the post-transaction period. This finding generally contradicts the semi-strong form of market efficiency (Birchler and Bütler (2007)). Nevertheless, European studies do not provide evidence supporting this theory. Prior research suggests that companies involved in European spin-offs do not perform abnormally after completion of the transaction (Veld and Veld-Merkoulova (2004) and Qian and Sudarsanam (2007)). Therefore, there is a discrepancy between US and European results. So far, this is explained by different applied methodologies between the existing studies analysing US or European samples (Veld and Veld-Merkoulova (2009)). Nevertheless, a wide base of US literature also documents strong improvements in the operating performance of parents and subsidiaries post-transaction. The elimination of negative synergies between the companies seems to reveal substantial potential for increases in efficiency and profitability (Desai and Jain (1999)). Literature regarding such improvements in European spin-offs is limited. Analyses comparable to US studies are not available, meaning that an overall performance assessment of European transactions is not possible. This thesis aims to close this gap by analysing European spin-offs regarding short-term announcement returns and long-term stock price and operating performances after completion of the transaction. The results shall allow for an overall assessment of abnormal performance in European spin-offs such that the value generation due to the transaction can be analysed in different stages of the divestment process. Furthermore, operating performance analyses shall close the gap of existing literature such that the thesis provides a complete framework for comparison of US and European transactions. Methodology The analysed sample of the thesis includes 117 Western European spin-offs completed between 1989 and 2012. Only transactions whose parent and subsidiary were not acquired in the first two years after completion are included such that long-term analyses are free of takeover premiums, indicating if spin-off companies provide abnormal returns on a stand-alone basis. Additionally, corporate news and listing prospectuses were used to exclude transactions that were based on pure merger or acquisition requirements, regulatory reasons or tax optimisations. The final sample consequently only includes spin-offs that were conducted in order to achieve operational improvements by dividing the combined firm into two separate companies. By using a market model following Veld and Veld-Merkoulova (2006), an event study of announcement stock returns shall indicate whether markets consider European spin-offs as value generating restructuring transactions. The analysis includes the event day and a three-day event window ranging from the day before to the day after the announcement. Abnormal long-term stock performance is calculated by using buy-and-hold returns for three years post-spin-off completion. Sample company returns are adjusted by a matching firm based on size, market-to-book ratio and headquarters location. In order to provide comparable results to studies analysing US spin-offs, the applied methodology follows their approach and an ordinary t-test instead of adjusted test statistics such as in previous European studies is used for significance testing. Results are presented for parents, subsidiaries and a pro-forma combination of the two spin-off companies to indicate whether and in which entity further abnormal performance can be observed after completion of the transaction. To test for operating improvements, changes in operating return on assets, operating return on sales and operating cash flow return on assets from the year previous to the transaction to the third year after completion are analysed. Following Hulburt, Miles, and Woolridge (2002), abnormal changes are calculated from three models using different benchmarks. Apart from raw changes in operating performance, industry adjusted as well as performance adjusted figures are reported. Results In keeping with previous literature, an average abnormal announcement return of 1.34% for the event day and 2.31% for the event window is observed in the spin-off sample of this thesis. Therefore, investors consider the transactions as value increasing and incorporate expected future benefits arising from the restructuring at its announcement. Furthermore, analyses of subsamples show that abnormal returns for parents spinning off a subsidiary operating in an unrelated industry are higher than for own-industry transactions. Consequently, spin-offs in particular create value the more the parent’s and subsidiary’s businesses differ. This value creation is not limited to single countries as returns remain significantly positive for regional samples. Therefore, spin-offs are considered as value driving transactions in general, not subject to regional regulatory or tax conditions. Results of the long-term analyses suggest that there is no abnormal stock performance in European spin-offs apart from the described short-term abnormal announcement returns. Investors seem to correctly assess effects on shareholder value prior to the spin-off completion. Buy-and-hold returns of subsidiaries and the pro-forma combined firms do not show stock returns that are significantly different in comparison to their matched firms. For parents even a weakly significant small underperformance can be observed for the first and second year after completion of the transaction. Therefore, it can be concluded that investments in European spin-off companies do not provide superior returns on a stand-alone basis. While the same statistical methods as applied in studies of US samples are used, no strong abnormal stock performance can be observed. As both parents and subsidiaries involved in US spin-offs provide superior returns, the findings of the thesis suggest that the discrepancy between US and European transactions cannot be explained by the test methodology and is rather based on economical differences. The operating performance analyses provide further evidence regarding this issue. Changes in return on assets, return on sales and cash flow return on assets do not show significant persisting patterns of abnormal operating performance. Only subsidiaries improve their return on assets significantly by 2.34% between the pre- and post-spin-off period. Nevertheless, no further strongly significant improvements can be observed, indicating that European spin-off companies cannot substantially enhance their operating performance as stand-alone firms. On the contrary, previous literature suggests that both parents and subsidiaries in US spin-offs are able to improve their performance significantly in several years after completion of the transaction (Daley, Mehrotra, and Sivakumar (1997) and Desai and Jain (1999)). Consequently, the discrepancy in the long-term stock performance between the two regions can be explained by the lack of operating enhancements in European spin-off firms. As operating returns do not increase substantially, neither company valuation does. Future research asking why European firms are not able to implement such improvements could provide further evidence about differences between US and European transactions. Potential explanations could be institutional differences such as a more active hostile takeover market in the US, putting additional pressure on management subsequent to the transaction, as spin-offs facilitate asset transfers by dividing group companies into single entities (Qian and Sudarsanam (2007)).
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