Master thesis
Is the Long-Term Performance of Spun-Off Firms Determined by
Spin-Off Characteristics?
Name: Patrick de Roos Student number: S2950545 E-mail: p.j.de.roos@student.rug.nl
MSc A&C track Accountancy
Supervisor: V-A. Porumb Date: 18 January 2021
1
Is the Long-Term Performance of Spun-Off Firms Determined by
Spin-Off Characteristics?
Abstract
Corporate spin-offs represent a very important type of divestiture which aims to restructure and improve the performance of parent firms along with the one of the spun-off subsidiaries. The improvements in performance are derived from a decrease in information asymmetry and an increase in both corporate focus and operational performance. In this paper, I examine whether spin-off characteristics have an influence on the long-term performance of the spun-off firm. I measure long term performance over the 12, 24, and 36 months after the effective date of the spin-off. The spin-off characteristics that are examined are pre-spin-off information asymmetry, relative size of the spin-off, focusing spin-off, and the board size of the parent firm. Empirical results indicate that the performance of the spun-off firms is positively influenced in the first two years after the spin-off. Further, I find that pre-spin-off information asymmetry has an incrementally positive effect on the performance of the spun-off in the third year after the spin-off. These results are robust to using multiple measures of long-term performance and clustering standard errors by firm. Overall, my findings suggest that it is beneficial for a spun-off firm to become a stand-alone entity and that the benefits are contextual.
Keywords: Spin-off; Long-term performance; Focussing; Information asymmetry; Board size
2 Introduction
A spin-off represents a (no cash) transaction where a parent company is distributing the equity ownership of its spun-off firm on a pro-rata basis to its present-day shareholders (Ozbek and Boyd, 2020). During the last decades, corporate spin-offs became an important restructuring technique for companies in the USA (Ozbek and Boyd, 2020). For example, the value of new shares that were issued by a spinoff transaction surpassed 50 billion dollars on the NYSE in 2014 (Campbell, 2019). The aim of a spin-off is usually a restructure of the parent firm and to improve the performance of both the parent-firm and the spun-off firm (Veld and Veld-Merkoulova, 2007). The announcement of a spin-off is usually received positively by the stock market (Veld and Veld-Merkoulova, 2007), with the short-term effects of spin-offs amounting up to 5.56% abnormal returns (Veld and Veld-Merkoulova, 2007). This effect is attributed to a decrease in information asymmetry, increase in focus, and an increase in operational performance (Veld and Veld-Merkoulova, 2007).1
In spite of the attention assigned to the short-term performance effects of spin-offs, the literature has neglected the implication of the divestitures on firms’ long-term performance. Long-term performance is important because it leads to more long-term investors and these have the motives to increase monitoring the corporate managers (Harford, 2018). Because of this increase in monitoring, firm managers are persuaded to make corporate choices that will have positive effects on the shareholder value (Harford, 2018). According to Cusatis, Miles and Woolridge (1993) an investment strategy that focusses on spun-off firms or firms that are spinning of a subsidiary produces a higher level of investment performance. Therefore the performance of the spun-off firms is critical for sustainable economic growth. In this thesis
1 Examples of spinoffs that got a lot of attention and involved over 20 billion dollars in equity were the HP’s
3 there will be a focus on the long-term performance of spun-off firms. The research question that I address in this thesis will therefore be:
How do spin-off characteristics impact the long-term performance of the spun-off?
In a related study, Cusatis, Miles and Woolridge (1993) assessed the performance of stock prices in U.S. spin-offs for up to three years after the spin-off. They found a significant long-term performance that was abnormal in a 2-year period after the spin-off had taken place. The effect on performance was documented for both the parent and the spun-off firm. Similarly, Desai and Jain (1999) studied whether the increase in focus is the driver for the gains on the stock market for companies that engage in a spin-off. They found a positive significantly abnormal return for 3 years after the spin-off had taken place. This result is mostly driven by the returns of the spun-off firm. While currently, relative to the aforementioned studies, more data is available and therefore the conclusions of an empirical test will me more representative,2, 3 this paper differentiates from previous research in multiple ways. For example, Cusatis, Miles
and Woolridge (1993) and Desai and Jain examined both the performance of the parent firm and the spun-off firm, while my thesis solely focusses on the performance of the spun-off firm. Additionally, Cusatis, Miles and Woolridge (1993) did not look at any characteristics of spin-offs that have influence on the long-term performance of spin-spin-offs. In turn, my thesis will assess four different characteristics of spin-offs.
In this research I perform several analyses. First, I assess if a spin-off has effect on the long-term performance. Second, I assess if the type of spin-off has influence on the long-term performance. Third, I test if the relative size of the spin-off has an influence on the spun-off
2 The papers of Cusatis, Miles and Woolridge (1993) and Desai and Jain (1999) were highly criticized by their
methodology by Fama (1998) and therefore it is not clear whether these results would still stand if a more sophisticated methodology was used.
3 Cusatis, Miles and Woolridge (1993) used data from spin-offs over the period 1965-1988 and Desai and Jain
4 firms’ long-term performance. Fourth, I assess if the parent board characteristics have influence on the spun-off firms’ long-term performance. Finally, I test if the pre-spin-off information asymmetry has influence on the spun-off firms’ long-term performance.
Firstly, I highlight the importance of studying the overall effect of the relation between a spin-off and the long-term performance of the spun-off firm, since it is especially relevant for managers and shareholders of firms who are planning to divest. To test my expectations, I use a sample of 1,257 observations from the U.S. between the years 1985 and 2019. I find that the performance of the spun-off firm is positively influenced in the first two years after the spin-off. This means that it is beneficial for a spun-off firm to become a stand-alone firm and the shareholders should favour such a corporate divestiture. Moreover, I find that the performance of the spun-off firm is negatively influenced in the third year after the spin-off. This implies that after two years the positive effects of the spin-off have disappeared. Additionally, I find that the pre-spin-off information asymmetry has an incrementally positive effect on the long-term performance in the third year after the spin-off. This result suggests that, for firms who have high information asymmetry, it might be beneficial to go through a divestiture. In addition, I found no significant effects for the type of spin-off, board size, and the relative size. These results suggest that these spin-off characteristics do not have an incremental effect on the long-term performance of the spun-off firm.
Despite the huge economic effect of spin-offs (Campbell, 2019) research has surprisingly little interest in how spun-off firms perform subsequent to the divestiture. My research contributes to the limited research on the performance of spun-off firms. Today, there are only a few studies who research parent firms’ linkages to spun-off firms and even less have focussed on the performance of spun-off firm rather than the parent (Semadeni and Canella, 2011). My research develops theories about the relationship between the spun-off firm and the parent firm. Very limited researchers have notified that connections between the parent firm and the
spun-5 off firm are meaningful and there are yet no theories about this connection (Semadeni and Canella, 2011).
A second contribution my research makes is that it adds to the contradicting research on long-term performance of the spun-off firms. Desai and Jain (1999) and Cusatis, Miles and Woolridge found a significant positive effect on the long-term performance of spin-offs. Veld and Veld-Merkoulova (2004), Sudarsanam and Qian (2007) and McConnell, Ozbilgin and Wahal (2001) found no significant long-term effect. I am looking at long-term performance because it is a critical outcome for sustainable economic growth because of the monitoring effects it has on the management of the firm (Harford, 2018).
The effect of each characteristic on the long-term performance of the spun-off firm is a third contribution to the research of spin-offs. The contextual effect of effect of pre-spin-off information asymmetry, relative size, board size and type of spin-off are important for managers of firms who want to divest. This is important for them to know because their goal is to make the optimal decisions and maximize their performance. Research on the contextual effect of spin-off characteristics adds to the knowledge of managers and they are then better able to make good decisions.
The rest of the paper is structured as follows. In Section 2 the theoretical background and hypotheses development will be discussed, in Section 3 the methodology. Section 4 includes results, together with the cross-sectional regression analysis. Section 5 presents the limitations. Finally, Section 6 provides a conclusion.
Theoretical background
Characteristics of spin-offs
Creating value for both the spun-off firm and the parent firm is the purpose of a spin-off (Ozbek and Boyd, 2020). Veld and Veld-Merkoulova (2008) stated that there are two different ways of
6 value creation: considering better opportunities and also focus on the core-business are the main ways of value-creation for the parent. For both the spun-off firm and the parent firm an increase in their efficiency in operations is a way of value-creation (Veld and Veld-Merkoulova, 2008). Achieving these outcomes effectively leads to positive reactions of the market and mostly possible future investors for both the spun-off firm and the parent (Ozbek and Boyd, 2020). This means that they are better able to compete against their rivals, because they are a stronger member in their specific sector (Ozbek and Boyd, 2020).
On the effective date of the spin-off the spun-off firm becomes an independent functioning firm from the parent firm and the shares are distributed on a pro-rata basis to the shareholders of the parent firm (Desai and Jain, 1999). A spin-off can only take place if three criteria are met according to the InternalRevenueCode, Section 335f (Desai and Jain, 1999). The first one is that there needs to be a business reason for the spin-off; second from the outstanding shares of the spun-off firm there needs to be at least 80 percent distributed to the parents’ firms shareholders; third between the spun-off firm and the parent firm there needs to be a trade or business relationship (Desai and Jain, 1999). When these three criteria are met it will officially be called a spin-off (Desai and Jain, 1999).
Long-term performance
Companies define their ideal shareholder as someone who has a long-term investment horizon (Beyer et al., 2014). This is caused by the assumption that long-term shareholders cause a good implementation of the corporate strategy and allows long-term investments without active traders putting pressures to improve the performance on the short-term and their distractions (Beyer et al, 2014). Monitoring with long-term investors is the most important mechanism to counter myopia of the management (Porter, 1992). According to Chen et al., (2007) and Gaspar et al., (2005) long-term investors have a competitive advantage in monitoring the managers
7 effectively, because of the spreading of benefits and costs over an investment horizon that is long-term.
Long-term investors have more influence on managers, have better information and can use this information more efficient (Harford, 2018). Long-term investors need less effort to influence managers and can gather information with less costs and they can therefore better engage in monitoring (Harford, 2018). Because of the buy and hold strategy of the long-term investors they have a good position to monitor the managers (Harford, 2018). Long-term investors do not sell firms that perform poorly and cause an improvement in operating performance and governance by putting pressure on the managers (Harford, 2018).
Bushee, (1998) found that long-term investors boost earnings by reducing pressure on the managers to reduce R&D expenditures. According to Chen et al., (2007) long-term investors have a positive influence on the outcomes of takeovers. Long-term investors soften the negative effects when stocks are being mispriced when equity is being issued and on the expenditure of capital (Derrien et al., 2013).
Stewardship theory
The stewardship theory originates in sociology and psychology and is designed especially for researchers to study circumstances in which executives as stewards are driven to behave in greatest concern of his principal (Donaldson & Davis,1991). In the stewardship theory the behaviour of the steward is more pro-organizational and collective behaviour has more utility relative to individual or self-serving behaviour (Davis et al., 1997). If there is a choice between pro-organizational and self-serving behaviour the steward will not go off the concerns of his organization. A steward is not willing to change his self-serving behaviour for collective behaviour. Because the steward gets more utility from collective behaviour the steward prefers collective behaviour, even when the interests are not in line between t he principal and the
8 steward (Davis et al., 1997). The steward wants to obtain the goals of the organization, profitability for example, therefore the behaviour of the steward is cooperative. This will benefit shareholders for example, because their goals are promoted by the steward. According to the stewardship theory there is a powerful link between the principals’ gratification and the prosperity of the organization. The steward is protecting and maximizing the wealth of the shareholders by the performance of the firm, because the utilization of the steward is maximized by in this situation (Davis et al., 1997).
Hypotheses Development
Long-term performance
Corporate spin-offs have a number of expected advantages and risks that might be associated with the corporate event (Ozbek and Boyd, 2020). According to Miles and Rosenfield (1983), a spin-off has a positive effect on abnormal returns and both increases the firm value of the spun-off and the parent and the spin-off therefore enhances the shareholder wealth. Increasing the company’s stock prices is also an expected positive effect of the announcement of the spin-off (Miles and Rosenfield, 1983). Second, and increase in corporate focus of the spun-spin-off firm is caused by the spin-off and the management only has to focus on the assets of the core business (Daley et al., 1997). The disposal of negative synergies between the divested and retained assets is the cause of the increase in focus (Daley et al., 1997). According to Daley et al. (1997) , there is also an expectation that the alignment of incentives will be better between the shareholders and the management of the company. A better understanding and estimati on of the spun-off firms’ possible value-creation is expected for both current investors and possible future investors (Bergh et al., 2008). A decrease in information asymmetry of the spun-off firm is also expected and this is caused by both an increase in transparency and operational effectiveness (Bergh et al., 2008).
9 The spin-offs are also associated with risks, due to the spun-off firms’ change of identity which can bring some organizational discomfort (Corley and Gioia, 2004). Determining strategies about its own growth, survival and success is another difficulty caused by the possible ambiguities spun-off firms might face (Corley and Gioia, 2004). Also, a loss of resources from the parent is also a risk caused by the independent status of the spun-off firm (Hambrick and Strucker, 1999). Managerial distress and organizational complexity are also likely created by their new independent ownership structure (Hambrick and Strucker, 1999). Negotiating about business contracts is also a risk for the spun-off firm because it cannot expect any assistance form the parent firm and therefore needs to deal on his own with other parties (Semadeni and Cannella, 2011). According to Semadeni and Canella (2011) it cannot be expected that the spun-off firm gets better deals than it would have got with help from the parent firm and this will cause a loss of economies. Risks and advantages are very common in spin-offs and the possible future investors, board members and top management should be conscious about them (Ozbek and Boyd, 2020). Although I identify both advantages and disadvantages of spin-offs, I still formulate the following hypothesis:
H1: Spin-offs are positively associated with the long-term performance of spun-off firms in the post-spinoff period.
Focussing/non-focussing spin-off
Shleifer and Vishny (1998) found that managerial entrenchment is value-destroying as is diversification by investments that are specific to managers. Divisions that have poor performance are often subsidized by good performing divisions and there is no consideration about alternative ways of investing in these poor performing divisions to improve them (Lamont, 1997 ; Shin and Stulz, 1998).
10 According to Comment and Jarrell (1995) the skills of the management may be good for the management of the core business, but not for managing the non-core assets. Improving focus may be the cause of an increase in performance when managers do not have to worry about operations that are not related to the core business (Comment and Jarrell, 1995). Firms that have a high level of diversification have difficulty with offering compensation that is based on stocks and is sensitive to the individual performance of the divisions (Comment and Jarrell, 1995).
Adjustments in the diversification level of a firm could have opposing effects on firm value (Veld and Veld-Merkoulova, 2007). For example, Servaes (1996) found in their research on diversification that the firm value of more-diversified firms is lower than the firm value that only have one segment. This is caused by bad decisions of mergers in the past, internal capital markets that are inefficient and agency problems (Veld and Veld-Merkoulova, 2007). In contrast, Hite and Owers (1983) found that the coordination of the operational activities of focussing firms is better and therefore have better performance. Nevertheless, a change in the diversification level of a firm can cause a potential loss in the collateral of the debt, because there are less assets that can act as collateral and the risk of assets also increases by the change of the firm’s diversification (Veld and Veld-Merkoulova, 2007). The volatility of assets can also be increased when a firm engages in a spin-off, this is the case when the cash flows are not completely correlated (Veld and Veld-Merkoulova, 2007). I consider that this explanation is however unlikely and therefore formulate the following hypothesis:
H2a: A focussing spin-off has an incrementally positive influence on the long-term performance of the spun-off firm.
11 Cavusgil (1984) discussed the relationship between firm size and performance, since bigger firms usually have a greater availability of management, production and financial resources (Moen, 2016). It is expected that the relationship is not between performance and the firm size, but seems to be between the different advantages which are caused by a larger firm size (Cavusgil, 1984). Bigger companies should have higher purchasing power, which causes that they are able to purchase inputs at a low price according the argument that was mentioned earlier (Moen, 2016). Because larger firms create high quantities, they can benefit from a large economies of scale (Moen, 2016). Larger firms have a lot of opportunities to express power in their distribution channels and have plenty resources for the development of a distribution system (Moen, 2016).
Firm size has an influence on the visibility of the company, so when a larger part of the parent spins-off the subsidiary is more visible. When the visibility of a firm is higher the firm is able to attract more investors, decrease the cost of capital and improve the liquidity, which have a positive influence on the performance of a firm (Bushee and Miller, 2012).
A negative effect of larger firms is that managers of larger firms are more self-interested and the goal of profit maximization might be substituted by managerial utility ( Niresh and Velnampy, 2014). Smaller companies also have the benefit that they can develop a unique product or a niche product (Moen, 2016). This is however unlikely and I therefore formulate the following hypothesis:
H2b: Relative size has an incrementally positive influence on the long-term performance of the spun-off firm.
Board size
According to Goodstein et al. (1994) there have been a lot of contrary arguments about the advantages and disadvantages of larger boards, but the majority of literature indicates that larger
12 boards improve to shape the corporate strategy. Haynes et al. (2019) found that effective monitoring is supported by larger boards. A larger board means that there are more resources that the company can use and there is a greater diversity in expertise (Goodstein et al., 2019). When the board size increases, there will be more opportunities for prestigious directors to be placed on the board, which is received well by the investors as well as the market (Certo, 2003). According to Beekun et al., (1998) when the board size is larger the board seems to more care about clearly understanding the conditions of their firms external environment.
According to theory, post spin-off relations with the parent company are expected to have significant influence on the performance of the spun-off firm (Semadeni and Canella, 2011) Woo, Willard and Daellenbach (1992) stated that spun-off firms find it difficult to adapt to their independency and that there needs to be a significant reorientation before the spun-off firm can improve their performance. The parent firm has a post spin-off supervision task by representing on the spun-off firms’ board (Woo et al., 1992).
There are also some negative aspects of a larger board. There can be communication and coordination problems because reaching consensus is harder and it is also difficult to schedule a meeting with the board, which leads to decisions that are made less-efficient (Jensen 1993). There can also be an increase in free-riding for the reason that an individual board member is not practising his diligence is correspondence with the size of the board (Lipton and Lorsch, 1992). This is however unlikely and I therefore formulate the following hypothesis:
H3a: Board size of the parent firm has an incrementally positive influence on the long-term performance of the spun-off firm.
Information asymmetry
The most prominent motivation for a spin-off is the reduction of information asymmetry between the market and company insiders cited by the management (Veld and
Veld-13 Merkoulova, 2007). An undervaluation by the market is caused by the operations in different industrial sectors and therefore the analysts cannot value the firm correctly (Veld and Veld-Merkoulova, 2007). After a spin-off, a detailed disclosure of all the separated divisions about their individual earnings and cost will be released in 8K and 10k financial statements (Krishnaswami and Subramaniam, 1999). The need for an estimation that is noisy of division-specific earnings and information about costs coming from financial statements is prevented because the shares are traded separately after a spin-off and these will be tracked by all kinds of analysts (Krishnaswami and Subramaniam, 1999). After a spin-off there is a significant turnover on the firms’ stock predicted by analysts (Gilson et al., 1998). A higher turnover on the firms’ stock predicted by analysts’ also causes greater precision in the earnings forecasts by analysts according to Gilson et al. (1998). According to this a spin-off eliminates undervaluation of one division when one division with poor performance affects the value of the other divisions that are more efficient and profitable (Krishnaswami and Subramaniam, 1999). Financing with external capital for growth opportunities would rise by the correction of the valuation of a division (Krishnaswami and Subramaniam, 1999).
The assets and operations of the different divisions are separated in a spin-off and there are no shared costs and therefore there is no manipulation of costs possible (Krishnaswami and Subramaniam, 1999). The information asymmetry about the operating efficiency and profitability is decreased of the different divisions and therefore the value of the divisions will increase according to the information hypotheses (Krishnaswami and Subramaniam, 1999). Without the existence of negative synergy between divisions the information asymmetry is a good motivation for a spin-off (Krishnaswami and Subramaniam, 1999). Therefore firms that have a high level of information asymmetry should engage more often in a spin-off then other firms (Krishnaswami and Subramaniam, 1999). According to Nanda and Narayanan (1997) all the firms that spin-off should be undervalued in an equilibrium and therefore the abnormal
14 returns should be positive at the announcement of the spin-off. If information asymmetry causes undervaluation, the value-creating effects resulting from a spin-off should be related to the information asymmetry (Krishnaswami and Subramaniam, 1999). The operating costs and efficiency of the different divisions are revealed to the market by a spin-off, therefore it is expected that a spin-off not only results a positive price reaction, but also causes a decrease in the information asymmetry level after a spin-off (Krishnaswami and Subramaniam, 1999).
Information asymmetry can also have negative effects on firm performance, because of adverse selection cost firms can barely get external capital in a cheap way (Drobetz et al., 2010). Now the firm is obligated to take investment decisions that are not optimal which might have a negative influence on the firm performance (Fosu et al., 2016). This is however unlikely and I therefore still consider the following hypothesis.
H3b: Pre-spin-off information asymmetry has an incrementally positive influence on the long-term performance of the spun-off firm.
Methodology
Sample and method
To test the hypotheses as described above a spin-off sample from the US is used. I used a dataset composed of spinoffs from SDC Platinum database. The data set consists of the parent names and the spun-off names with their indicators. I enriched through data-collection the previously missing ISIN identifying codes of this dataset. The financial information used in this thesis is collected from the Compustat database, from the years 1985-2019. The data from Compustat is merged via the GVKEY’s of the spin-off firms. The data for the board size hypothesis is collected from the BoardEx data base and covers the years 1999-2019. The data from BoardEx is merged via the ISIN codes of the spin-off firms.
15 The variables used for testing the hypothesis are described in Table 1. After gathering all the data for the hypothesis testing the observations with a fiscal year that is 4 years later than the spin-off completion year are deleted and also fiscal years before the spin-off completion year. Research and Development expenses and Selling, General and Administrative expenses that were missing were set to a zero because otherwise the dataset would significantly decrease. All missing data was deleted. After that the variables were excluded at 1% and 99% by winsorizing. Next to that, I have standardized all continuous variables.
To test the hypotheses, I created a dummy variable to indicate if the fiscal year was 1, 2 or 3 years after the effective date of the spin-off. These dummies are used to indicate what effect these years have on the long-term performance measures used in this thesis. To test the effect of the spin-off characteristics on the long-term performance the 1, 2 and 3 years after spin-off dummy will be interacted with the different off characteristics. The effect of the post spin-off dummies on the long-term performance measures will be compared with the interaction between the post spin-off dummy and the characteristic to see if the spin-off characteristic influences the long-term performance.
Long-term performance measures
The first measure of long-term performance used in this thesis is the return on assets (ROA). I have considered several reasons for the selection of ROA as a measure of long-term performance. First, net income can be influenced by one-time changes and this effect is decreased by ROA (Daley et al., 1997). Second, because there is no evidence where the source of decrease or improvement lies, ROA is preferred as a measure to asset turnover or profit margin on its own (Daley et al., 1997). The product of asset turnover and asset margin is ROA and non-significant small increases in either asset turnover or profit margin ma y have significant effects on ROA (Daley et al., 1997). The theory in this thesis is insufficient to provide insight in which one of the two determinants of ROA has the most influence on the
16 value creating process in spin-offs (Daley et al., 1997). ROA is a better measure of long-term performance for the purpose of this thesis, because it is able to measure the performance change from both profit margin and asset turnover (Daley et al., 1997).
A change in the net capital expenditures (CAP) is used as an addition to the ROA measure. If no change in ROA is observed, a growth of operations could be a value creating source following the spin-off (Daley et al., 1997). New investments can change the operations scale and this is captured by the change in CAP (Daley et al., 1997). A motivation for a spin-off can be to control a problem of under-investment which is associated with debt and this is provided by John (1993). The change in CAP should clear up on this source of value creation from spin-offs (Daley et al., 1997). The CAP is calculated by dividing capital expenditures by sales (Daley et al., 1997). Changes in performance are used because according to Barber and Lyon (1996) tests that include changes have a better ability to detect abnormal performance than just using the levels of performance (Daley et al., 1997).
The third measure of long-term performance used in this thesis is the two-year percentage change in the market capitalization ( I have operationalized the market value of equity as being product of closing annual share price and common shares outstanding (Ozbek and Boyd, 2020)). The decisions of investors are linked to the market capitalization of a firm (Matolcsy and Wyatt, 2008). A higher market capitalization than rivals in a firm’s industry is also a cause of a corporate image that is more positive (Smith et al., 2010). Future earnings of a firm can be predicted by the current market capitalization (Abeysekera, 2011). This measure of long-term performance is a good measure to capture the impact of the different spin -off characteristics after the spun-off has become an independent entity (Ozbek and Boyd, 2020).
The fourth measure of long-term performance is Tobin’s Q, as a reflection of the perception of the current and possible future profitability of a firm (Carpenter, 2002). Tobin’s Q is a widely used measure of long-term performance and is defined as the ratio of the market
17 value of a firm to the replacement value of its assets (Richard et al., 2007). The measure of Tobin’s Q used in this thesis is the sum of total liabilities and market capitalization divided by total assets (Hawn and Ioannou, 2016) This is a commonly used measure of Tobin’s Q and is shown to be a good measurement that is in accordance with the measures of Tobin’s Q, such as used by Lewellen and Bidranath (1997).
Independent variables
The size of the board is measured as the number of directors of the board (Ozbek and Boyd, 2020). A focussing spin-off is defined as a spin-off where the spun-off firm and the parent firm have a different two-digit SIC code (Daley et al., 1997). A dummy is created for this variable where a focussing spin-off got a 1 and a non-focussing spin-off got a 0. The ratio of market capitalization of the spun-off firm to the combined market capitalization of the spun-off firm and the parent firm is the measure used of the relative size of the spin-off (Krishnaswami and Subramaniam, 1999). According to Smith and Watts (1992) managers have good knowledge of potential cash flows of their assets and the firm’s investment opportunity set (Clarke and Shastri, 2000). Therefore, investment opportunity set is used as a proxy for a measure of information asymmetry (Clarke and Shastri, 2000). McLaughlin et al. (1998) used the ratio of market value to book value of equity for a measure of information asymmetry where an information asymmetry dummy was created (Clarke and Shastri, 2000). If the information asymmetry was higher than the median of the sample than it was given a 1 and a 0 if the information asymmetry was lower (McLaughlin et al., 1998).
Control variables
In my model I included control variables that may affect the long-term performance of the firm. For controlling other intangibles that could affect the long-term performance, I included Selling, General & Administrative Expenses (SG&A costs) and Research and Development Expenses
18 (R&D costs) (Hawn and Ioannou, 2016). Second, the degree of diversification (Diversification) is represented by the natural logarithm of the four-digit SIC code (McWilliams & Siegel, 2000). Following prior literature on long-term performance, I included measures of annual sales growth (Sales Growth), annual logged sales (Logged Sales) and sales (Sales) (Belenzon, 2012). These three variables capture the effect on the market-value specification (Hawn and Ioannou, 2016). Net income (Net Income) and cost of goods sold (Cost of Goods Sold) are used as additional covariates and this is consistent with other research where Tobin’s Q is used (Salinger, 1984). By the use of a firm’s SIC code, an Industry Dummy is created that differentiated between service (SIC code = 1 if less than 2000 or greater than 3999) and manufacturing firms (SIC code = 0 from 2000 to 3999) (Gomez-Mejia, et al., 2003). This allows me to compare the results between manufacturing and service firms (Dess and Beard, 1984). Finally, a Year Dummy is created and indicates whether the spin-off event took place during the financial crisis (Thams et al., 2018). More specifically, the financial crisis took place in the years 2001, 2002, 2008 and 2009 (Thams et al., 2018). These years were coded with a 1 and all other years with a 0.
Results
Descriptive statistics and correlations
The descriptive statistics for all the unstandardized variables are presented in Table 2. The descriptive statistics are from the whole sample of 1257 and show the number of observations, mean, standard deviation, median, minimum and maximum. Information Asymmetry has a mean of 0.944 with a standard deviation of 0.229, the minimum is 0.000, the maximum is 1.000 and the median is 1.000. Relative Size has 1151 observations because some data of firms were missing on the year of the effective date of the spin-off. The mean of Relative Size is 29% with a standard deviation of 22%, the minimum is 0%, the maximum is 99,7% and the median is
19 24%. Focussing/non-Focussing has a mean of 0.59 with a standard deviation of 0.492, the minimum is 0.000, the maximum is 1.000 and the median is 1.000. Board Size has 524 observations because the data from BoardEx is from 1999 forward and the rest of the data was from 1985 forward. Board Size has a mean of 9.729 with a standard deviation of 2.543, the minimum is 5, the maximum is 26 and the median is 10. Tobin’s Q has a mean of 0.418 with a standard deviation of 0.591, the minimum is -1.315, the maximum is 3.064 and the median is 0.30. MC Difference has 525 observations because there was some data missing for years. The mean of MC Difference is 42% with a standard deviation of 130%, the minimum is -100%, the maximum is 1323% and the median is 12%. ROA Difference has 864 observations because not all data was available for all firm years. ROA Difference has a mean of -0.005 with a standard deviation of 0.231, the minimum is -1.431, the maximum is 2.942 and the median is 0.00. CAP Difference has 850 observations because not all data was available for all firm years. CAP difference has a mean of 0.002 with a standard deviation of 1.436, the minimum is -23.220, the maximum is 23653 and the median is 0.00. The results of Relative Size and Board Size are mostly in line with prior research (Krishnaswami and Subramaniam, 1999; Ozbek and Boyd, 2020). Tobin’s Q is not in line with prior research, this might be because the other research did not focus on spin-offs. MC Difference is also not in line with prior research, this might be because the other research had a shorter time frame, namely between 2000 and 2014. The results of Information Asymmetry, Focussing/non-Focussing, ROA Difference and CAP Difference I could not compare with prior research because these were not shown in the descriptive statistics.
Table 3 presents the correlations between the different variables used in this study. I perform this analysis to ascertain the probability of multicollinearity in my data. The correlation between SG&A Costs and R&D Costs is 0.70. This means that they are strongly correlated with each other. The correlation between Sales and SG&A Costs is 0.72. This means that they are strongly correlated with each other, this is also expected because if sales increases the costs
20 related to those sales should also increase. The correlation between Sales and Cost of Goods Sold is 0.95. This means that they are strongly correlated with each other, this is also expected because if sales increases the costs of the products sold should also increase. These results should have no influence on my results because these are all control variables.
As per Table 3, Information Asymmetry is positively significant correlated with the dependent variable MC Difference, this might mean that higher pre-spin-off information asymmetry is associated with a higher difference in market capitalization. Relative size is negatively significant correlated with ROA Difference and positively significant correlated with Tobin’s Q, this might mean that a larger relative size of the spin-off is associated with an increase in Tobin’s Q and a decrease in the ROA level. Focussing/non-Focussing is negatively significant correlated with ROA Difference and Tobin’s Q, this might mean that when a spin-off is focussing this results in a decrease in the ROA level and Tobin’s Q. Board Size is negatively significant correlated with Tobin’s Q, this might mean that a larger board is associated with a decrease in Tobin’s Q.
The control variables that are significantly correlated with ROA Difference are Logged Sales (r =.12) and Net Income (r =.10). CAP Difference is significantly correlated with Sales Growth (r =.08). Tobin’s Q is significantly correlated with R&D Costs (r =.09), Logged Sales (r =.18), Sales Growth (r =.17), Year Dummy (r =-.05), Net Income (r =.10) and Cost of Goods Sold (r =-.07). MC Difference is significantly correlated with Sales Growth (r =.13) and Year Dummy (r =.16).
Main Results
In Tables 4 and 5 the results for Hypothesis 1 are shown. Specifically, I tested if a spin-off has an effect on the long-term performance of the spun-off firm. In Table 4 the results of the first two years after the effective date of the spin-off are shown. In column (3) the coefficient of 1
21 Year After Spin-off is positive and significant (r = 0.066, p<0.01), indicating that it positively affects the change in ROA. In column (3) the coefficient of 2 Year After Spin-off is positive and significant (r= 0.039, p<0.05), indicating that it positively affects the change in ROA. In Table 5 the results of the third year after the spin-off are shown. In column (3) the coefficient of 3 Year After Spin-off is negative and significant (r= -0.053, p<0.01), indicating that it negatively affects the change in ROA. Overall, this is partly in line with Hypothesis 1 and suggest that a spin-off has a positive effect on the long-term performance of the spun-off firm in the first two years after the spun-off and has a negative effect on the long-term performance in the third year after the spin-off.
Table 4 and 5 also show the effect of the spin-off on MC Difference. Data for 1 Year After Spin-off is not available because the 2 year percentage change is calculated and therefore the spun-off firm needs to exist 2 years before this can be calculated. In Table 4 column (2) the coefficient of 2 Year After Spin-off is positive and significant (r= 0.179, p<0.1), indicating that it negatively affects the change in market capitalization. In Table 5 column (2) the coefficient of 3 Year After Spin-off is negative and significant (r= -0.179, p<0.1), indicating that it negatively affects the change in market capitalization. Overall, this is partly in line with Hypothesis 1 and suggest that a spin-off has a positive effect on the long-term performance of the spun-off firm in the first two years after the spun-off and has a negative effect on the long-term performance in the second and third year after the spin-off.
In Tables 4, 5, 6, 7 and 8 the results for Hypotheses 2a, 2b, 3a and 3c are shown. In Table 6 the results are shown for 1 year after the effective date of the spin-off, in Table 7 2 years after and in Table 8 for 3 years after. For Hypothesis 2a Table 4 column (3), Table 4 column (2), Table 5 column (2), Table 5 column (3), Table 6 column (8), Table 7 columns (10) and (11) and Table 8 columns (10) and (11) are used. In Table 4 column (3) the coefficient of 1 Year After Spin-off is positive and significant (r = 0.066, p<0.01) and the coefficient of 1 Year
22
After Spin-off interacted with Focussing/non-Focussing is negative and insignificant (r= -0.011). These results indicate that the type of spin-off does not have an incremental effect on
the change in ROA of the spun-off firm in the first year after the spin-off. In Table 4 column (3) the coefficient of 2 Year After Spin-off is positive and significant (r= 0.039, p<0.05) and the coefficient of 2 Year After Spin-off interacted with Focussing/non-Focussing is positive and insignificant (r= 0.005). These results indicate that the type of spin-off does not have an incremental effect on the change in ROA of the spun-off firm in the second year after the spin-off. In Table 4 column (2) the coefficient of 2 Year After Spin-off is positive and significant (r= 0.179, p<0.1) and the coefficient of 2 Year After Spin-off interacted with Focussing/non-Focussing is positive and insignificant (r= 0.083). These results indicate that the type of spin-off does not have an incremental effect on the change in market capitalization in the first two years after the spin-off . In Table 5 column (3) the coefficient of 3 Year After Spin-off is negative and significant (r= -0.053, p<0.01) and the coefficient of 3 Year After Spin-off interacted with Focussing/non-Focussing is positive and insignificant (r= 0.008). These results indicate that the type of spin-off does not have an incremental effect on the change in ROA of the spun-off firm in the third year after the spin-off. In Table 5 column (2) the coefficient of 3 Year After Spin-off is negative and significant (r= -0.179, p<0.1) and the coefficient of 3 Year After Spin-Spin-off interacted with Focussing/non-Focussing is negative and insignificant (r= -0.083). These results indicate that the type of spin-off does not have an incremental effect on the change in market capitalization of the spun-off firm in the second and third year after the spin-off. Overall, these results are not in line with Hypothesis 2a and suggest that that the type of spin-off does not have an incremental effect on the long-term performance of the spun-off firm.
For Hypothesis 2b Table 4 column (3), Table 4 column (2), Table 5 column (2), Table 5 column (3), Table 6 column (5), Table 7 columns (6) and (7) and Table 8 columns (6) and (7) are used. In Table 4 column (3) the coefficient of 1 Year After Spin-off is positive and significant
23 (r = 0.066, p<0.01) and the coefficient of 1 Year After Spin-off interacted with Relative Size is negative and insignificant (r= -0.014). These results indicate that the relative size of the spin-off does not have an incremental effect on the change in ROA of the spun-spin-off firm in the first year after the spin-off. In Table 4 column (3) the coefficient of 2 Year After Spin-off is positive and significant (r= 0.039, p<0.05) and the coefficient of 2 Year After Spin-off interacted with Relative Size is positive and insignificant (r= 0.006). These results that the relative size of the spin-off does not have an incremental effect on the change in ROA of the spun-off firm in the second year after the spin-off. In Table 4 column (2) the coefficient of 2 Year After Spin-off is positive and significant (r= 0.179, p<0.1) and the coefficient of 2 Year After Spin-off interacted with Relative Size is negative and insignificant (r= -0.163). These results indicate that the relative size of the spin-off does not have an incremental effect on the change in market capitalization of the spun-off firm in the first and second year after the spin-off. In Table 5 column (3) the coefficient of 3 Year After Spin-off is negative and significant (r= -0.053, p<0.01) and the coefficient of 3 Year After Spin-off interacted with Relative Size is positive and insignificant (r= 0.009). These results indicate that the relative size of the spin-off does not have an incremental effect on the change in ROA of the spun-off firm in the third year after the spin-off. In Table 5 column (2) the coefficient of 3 Year After Spin-off is negative and significant (r= -0.179, p<0.1) and the coefficient of 3 Year After Spin-off interacted with Relative Size is positive and insignificant (r= 0.163). These results indicate that the relative size of the spin-off does not have an incremental effect on the change in market capitalization of the spun-off firm in the second and third year after the spin-off. Overall, these results are not in line with Hypothesis 2b and suggest that the relative size of the spin-off does not have an incremental effect on the long-term performance of the spun-off firm.
For Hypothesis 3a Table 4 column (3), Table 4 column (2), Table 5 column (2), Table 5 column (3), Table 6 column (11), Table 7 columns (14) and (15) and Table 8 columns (14)
24 and (15) are used. In Table 4 column (3) the coefficient of 1 Year After Spin-off is positive and significant (r = 0.066, p<0.01) and the coefficient of 1 Year After Spin-off interacted with Board Size is negative and insignificant (r= -0.017). These results indicate that the board size of the parent firm does not have an incremental effect on the change in ROA of the spun-off firm in the first year after the spin-off. In Table 4 column (3) the coefficient of 2 Year After Spin-off is positive and significant (r= 0.039, p<0.05) and the coefficient of 2 Year After Spin-off interacted with Board Size is positive and insignificant (r= 0.019). These results indicate that the board size of the parent firm does not have an incremental effect on the change in ROA of the spun-off firm in the second year after the spin-spun-off. In Table 4 column (2) the coefficient of 2 Year After Spin-off is positive and significant (r= 0.179, p<0.1) and the coefficient of 2 Year After Spin-off interacted with Board Size is positive and insignificant (r= 0.014). These results indicate that the board size of the parent firm does not have an incremental effect on the change in market capitalization of the spun-off firm in the first two years after the spin-off. In Table 5 column (3) the coefficient of 3 Year After Spin-off is negative and significant (r= -0.053, p<0.01) and the coefficient of 3 Year After Spin-off interacted with Board Size is negative and insignificant (r= -0.001). These results indicate that the board size of the parent firm does not have an incremental effect on the change in ROA of the spun-off firm in the third after the spin-off. In Table 5 column (2) the coefficient of 3 Year After Spin-off is negative and significant (r= -0.179, p<0.1) and the coefficient of 3 Year After Spin-off interacted with Board Size is negative and insignificant (r= -0.014). These results indicate that the board size of the parent firm does not have an incremental effect on the change in market capitalization of t he spun-off firm in the second and third year after the spin-off. Overall, these results are not in line with Hypothesis 3a and suggest that the board size of the parent firm does not have an incremental effect on the long-term performance of the spun-off firm.
25 For Hypothesis 3b Table 4 column (3), Table 4 column (2), Table 5 column (2), Table 5 column (3), Table 6 column (2), Table 7 columns (2) and (3) and Table 8 columns (2) and (3) are used. In Table 4 column (3) the coefficient of 1 Year After Spin-off is positive and significant (r = 0.066, p<0.01) and the coefficient of 1 Year After Spin-off interacted with Information Asymmetry is negative and insignificant (r= -0.094). These results indicate that pre-spin-off information asymmetry does not have an incremental effect on the change in ROA of the spun-off firm in the first year after the spin-spun-off. In Table 4 column (3) the coefficient of 2 Year After off is positive and significant (r= 0.039, p<0.05) and the coefficient of 2 Year After Spin-off interacted with Information Asymmetry is negative and insignificant (r= -0.034). These results indicate that pre-spin-off information asymmetry does not have an incremental effect on the change in ROA of the spun-off firm in the second year after the spin-off. In Table 4 column (2) the coefficient of 2 Year After Spin-off is positive and significant (r= 0.179, p<0.1) and the coefficient of 2 Year After Spin-off interacted with Information Asymmetry is negative and insignificant (r= -0.209). These results indicate that pre-spin-off information asymmetry does not have an incremental effect on the change in market capitalization of the spun-off firm in the first two years after the spin-off. In Table 5 column (3) the coefficient of 3 Year After Spin-off is negative and significant (r= -0.053, p<0.01) and the coefficient of 3 Year After Spin-off interacted with Information Asymmetry is positive and significant (r= 0.113, p<0.1). These results indicate that pre-spin-off information asymmetry has an incrementally positive effect on the change in ROA of the spun-off firm in the third year after the spin-off. In Table 5 column (2) the coefficient of 3 Year After Spin-off is negative and significant (r= -0.179, p<0.1) and the coefficient of 3 Year After Spin-off interacted with Information Asymmetry is positive and insignificant (r= 0.209). These results indicate that pre-spin-off information asymmetry does not have an incremental effect on the change in market capitalization of the spun-off firm in the second and third after the spin-off. Overall these results are in line with Hypothesis 3b and
26 suggest that the level of pre-spin-off information asymmetry has an incrementally positive effect on the long-term performance in the third year after the spin-off.
Control variables
In Tables 4, 5, 6, 7 and 8 the control variables also have an effect on the long-term performance measures. In Table 4 R&D Costs have a positive and significant effect on Tobin’s Q and MC Difference. Logged Sales has a significant negative effect on Tobin’s Q and a significant positive effect on ROA Difference. Sales Growth has a significant positive effect on Tobin’s Q and MC Difference and a significant negative effect on CAP Difference. Sales has a significant negative effect on ROA Difference. Year Dummy has a significant negative effect on MC Difference and ROA Difference. Net Income has a significant positive effect on Tobin’s Q and ROA Difference. These results are mostly in accordance with Tables 5, 6, 7 and 8 but Logged Sales has a significant positive effect instead of negative in Tables 6, 7 and 8. Diversification has a significant positive effect in Tables 6 (4) and 8 (5) on Tobin’s Q. Overall, these results are mostly in line with prior research (Hawn and Ioannou, 2016; Ozbek and Boyd, 2020; Richard et al., 2007).
Additional results
Tables 4 and 5 also shows the effect of a spin-off on other measurements of long-term performance. In Table 4 column (1) the coefficient of 1 Year After Spin-off is negative and significant, indicating that it does not affect Tobin’s Q. In Table 4 column (1) the coefficient of 2 Year After Spin-off is also negative and insignificant, indicating that it does not affect Tobin’s Q. In Table 4 column (1) the coefficient of 3 Year After Spin-off is positive and insignificant, indicating that it does not affect Tobin’s Q. In Table 4 column (4) 1 Year After Spin-off is positive and insignificant, indicating that it does not affect the change in CAP. In Table 4 column (4) 2 Year After Spin-off is positive and insignificant, indicating that it does not affect
27 the change in CAP. In Table 4 column (4) 3 Year After Spin-off is negative and insignificant, indicating that it does not affect the change in CAP. In Table 7 column (16) the coefficient of Board Size interacted with 2 Year After Spin-off is positive and significant (r= 0.370, p<0.1). Although this is a significant result, this cannot be used for the Hypothesis because the effect of the spin-off on the difference in CAP in the second year after the spin-off was not significant. Overall, these results cannot be used for the Hypotheses because of a lack of significant results.
Robustness tests
In order to test for the robustness of my findings I use different measures of long-term performance. The change in ROA aims to capture the operational changes in performance of the spun-off firm. The difference in market capitalization aims to capture the changes from a market perspective. These two measures are important, because they reflect two different dimensions of performance. My estimations are consistent across using the two dependent variables, which strengthens the believability of my results.
I also performed the regressions with clustering standard errors by firm. These regressions gave similar results to the normal regressions. I also performed the regressions with a robust function and this function mitigates the effect of influential observations and outliers. This regression also gave similar results compared to the normal regressions . Because these two different forms of regressions gave similar results compared to the normal regressions , the believability of my results is strengthened.
Limitations
In order to get the desired results, this research has certain limitations. First, this research focusses only on spin-offs of firms in the USA and therefore the generalizability for other countries is limited. Second, long-term performance can be measured by many different measures, for example the matched firm principle to capture abnormal returns used by
28 McConnell et al. (2001). In this research four measurements of long-term performance are used and it might be that other measures such as matched firm principle used by McConnell et al. (2001) are better able to capture the effect on the performance of the spun-off firm. Next to that my research focusses only on the first three years in the post spin-off period. Because of the change in identity of the spun-off firm and the firm needs to get used to his independence and this can bring some organizational discomfort (Corley and Gioia, 2004). Therefore, it might be that the first three years in the post spin-off period are not a good representation of the long-term performance of the spun-off firm. Another limitation in this research is the proxy used for pre-spin-off information asymmetry. According to Clarke and Shastri (2000) there are three general categories of measuring information asymmetry, the first one is the investment opportunity set, the second one is based on the microstructure of the market and the final one is based on the forecasts of analysts. In this research the one based on the investment opportunity set is used, using a combination of the other categories might give a more representative result.
Conclusions
I researched whether a spin-off has an influence on the long-term performance of the spun-off firm. Next to that I investigated whether different spin-off characteristics have an incremental effect on the long-term performance of the spun-off firm. I found that the performance of the spun-off is positively associated with a spin-off in the first two years in the post spin-off period. I further found that the performance of the spun-off firm is negatively influenced by the spin-off event in the third year in the post spin-spin-off period. Further, I found that pre-spin-spin-off information asymmetry has an incrementally positive effect on the performance of the spun-off firm in the third year in the post spin-off period. Regarding the effect of spin-off type - relative size of the spin-off and the board size - I did not find any significant results in my estimations,
29 that indicates that these spin-off characteristics do not have an incremental effect on the performance of the spun-off firm.
My research contributes to the literature of spun-off firms, long-term performance and the spin-off characteristics. I extend the spun-off literature by showing that it is beneficial for spun-off firms to become a stand-alone firm and that shareholders should favour such a divesture. Next to that I extend the spun-off literature by showing that there are relationships between the parent firm and the spun-off firm. Specifically, I show empirical evidence that pre-spin-off information asymmetry of the parent firm has incrementally positive effect on the performance of the spun-off firm. I extent the long-term performance literature by showing that there is a significant effect of the spin-off on the performance of the spun-off firm. Prior literature is contradicting about the long-term performance after spin-offs. Sudarsanam and Qian (2007) found no significant effect while Desai and Jain (1999) did find a significant effect. I further add to research by showing how different spin-off characteristics influence the long-term performance of spun-off firm. This is especially important for managers of firms who are planning to divest their firm. Overall, my findings suggest that it is beneficial for a spun-off firm to become a stand-alone entity and that the benefits for spun-offs are contextual.
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