Equity carve-outs, efficiency gains, and market timing

  • B├Ârseneinf├╝hrungen von Tochtergesellschaften, Effizienzeffekte und Market Timing

Baltin, Matthias Florianus Paul; Brettel, Malte (Thesis advisor)

Aachen : Publikationsserver der RWTH Aachen University (2008)
Dissertation / PhD Thesis

Aachen, Techn. Hochsch., Diss., 2008

Abstract

In an equity carve-out (ECO), an initial public offering fully or partially separates a subsidiary from a formerly consolidated group of companies. The present dissertation evaluates, both theoretically and empirically, the resultant economic effects to arrive at an overall assessment of ECOs. The study is based on 174 US ECOs of the 1995 to 2002 period. Agency theory has been chosen as unifying theoretical framework. To illustrate how ECOs affect the losses engendered by the separation of ownership and control, the determinants of agency costs are reviewed for the various agency relationships in a governance structure of parent and subsidiary firms. Results indicate that ECO firms exhibit lower profitability and higher leverage, but proportionate or better investment opportunities than peer firms, suggesting that these transactions are intended to finance otherwise foregone growth opportunities. While event study results on the ECO announcement document robustly positive abnormal returns, a long-term analysis of the post-offer share price indicates significant underperformance of both parent and subsidiary. This finding is robust to variations in return normalization, to the application of event-time versus calendar methodology, and to variations in the aggregation of return over time. To investigate this contradiction, ten ECO efficiency hypotheses are developed and tested via multiple regression analysis. Efficiency effects are strongly associated with the positive ECO announcement returns but uncorrelated with the long-term underperformance. To explain this underperformance, the study considers the possibility that markets may not be fully efficient and that ECOs may be subject to market timing. Based on arguments of prospect theory and asymmetric information, a behavioral model is developed whereby better-informed managers exploit erroneous believes of irrational investors by selling subsidiary equity at more than its fundamental value. This model is synthesized into a set of testable hypotheses, according to which ECOs that are timed will exhibit pre-event run-ups of abnormal return as well as some persistence of positive abnormal return after the offer. Furthermore, the cross-sectional variance of post-offer per-period abnormal return will decrease over time. All hypotheses of market timing are confirmed for the full sample. Long-term underperformance can be exclusively traced to ECOs of the 1998-2000 hot-market period. Descriptive sample characteristics support the finding that hot-market ECOs have been inspired by attempts to time the offer. Key findings of this study are contrasted to research on German ECOs, which indicates that the performance of ECOs is broadly comparable across the two geographies. Findings further highlight the relatively more important role of blockholder monitoring in Germany and of transparency by public disclosure in the US, consistent with research on comparative corporate governance. On the whole, the dissertation reaches a positive verdict on ECOs. Their long-term underperformance is not an effect of the transaction but the transaction a consequence of a pre-offer build-up of excess valuation. To future research, the present dissertation offers a novel methodology to re-examine the time-variance of the long-term underperformance of regular initial and seasoned public offerings of equity and a basis to advance the study of geographic idiosyncrasies of financing and restructuring transactions.

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