Businesses usually look at multiple avenues to drive growth
when revenues slow down, raising capital becomes difficult, overheads increase
and shareholders demand more returns. Corporate executives start going through
their strategic-planning exercises and discuss about the businesses and what it
would take to really be successful over the next five to ten years and grow the
value of the corporation.
Corporate spin-offs enable incumbent organizations to
exploit new opportunities and are considered to be an important driver of new business
in ongoing enterprises. Spin-offs enable incumbents to
experiment with new technologies and business practices that would not be
possible within the parent firm due to internalization impediments Therefore, a
spin-off allows the firm to concentrate mainly on its core competencies and
allow the new unit to focus on the newer markets and opportunity on a
standalone business. Thus, in such scenarios, companies look at their business
units and which of them are central to their strategy and drive long term
growth. The new division, then, has autonomy in deciding its capital structure,
resource allocations and implement cost efficiencies as needed.
Additionally, success of spin off’s also depend on factors
like nature of the industry of the spun off division, new management of the
company, legal, resource and capital sharing arrangements with the parent.
Management must do a significant cost benefit analysis on expected synergies
and long term potential of the demerger before going ahead with the decision.
Considering the example of Canadian Pacific, where it decided to spin off four
of its subsidiaries, including Canadian Pacific Railway and PanCanadian
Petroleum. After the spin-off, Canadian Pacific’s only significant business
would consist of Canadian Pacific Hotels. As per CEO of the firm, he mentioned
the spinoffs will reward the shareholders by unlocking the full value of each
business and provide them an excellent opportunity to participate in future
growth and development of the business and their industries.
The research paper studies different reasons for carrying
out spinoffs of business units and their outcome on company’s profitability,
capital structure, financing and those on the spun off units.
Beginning the analysis with Berger and Ofek (1995),
extensive research has shown that the equity of diversified firms is traded at
a discount compared to single business firms. A spin-off is a relatively simple
way to improve the focus of the firm and to avoid the diversification discount.
Therefore, a spin-off allows the firm to concentrate on its core business. As
per Robert Gartner and David Scharfstein in their study, capital expenditures
showed greater response to changes in growth opportunities after a division was
spun off. Also, companies operating in high-growth sectors tended to increase
capital investment following the spinoff, whereas investment declined for post-spinoff
companies operating in low-growth sectors. Additionally, for unrelated
industries, following a spinoff, the study predicted, a one-standard-deviation
increase in Tobin’s Q, or investment opportunity, would cause investment to
rise 11.5% as compared to average company.
As per Mark, Evan and Ram(2015), spinoffs since 2009
resulted in abnormal return to the shareholders of spinoff companies (measured after
the spinoff as the combined return of the RemainCo and SpinCo) rises to 10%-15%
over the next two years. It indicated that the future deals have the potential
to create as much as over $200 billion of value, which represents about 2% of
the current market capitalization of all U.S. companies.
Desai and Jain (1999) used matching firm approach to calculate returns. They
find significantly positive abnormal returns for the 3-year period following
the spin-offs. In addition, they find that the returns are much better for
focus-increasing companies. The abnormal returns for the focus-increasing
companies are significant 11.12%, 20.77% and 33.36% over respective holding
periods of one, two or three years following the spin-offs. This contrasts to
non-significant abnormal returns of -0.96%, -7.66% and -14.34% in the same
respective periods for the non-focus-increasing spin-offs.
Daley, Mehrotra, and Sivakumar (1997) emphasize a positive relation between
firm value and corporate focus on spinoffs involving assets outside the core
business of the firm. The result that larger spin-offs are associated with
higher abnormal returns is possibly related to the industrial focus result
The research would be divided into 2 parts:
1. A study of different examples leading to corporate spin
offs. Here, the factors leading to spinoffs i.e. loss making subsidiary,
unrelated business, industry focus, increase leverage would be analyzed. This
would help us understand the rationale behind various demergers/spinoffs in
2. In the 2nd part, we will study the outcome of
the spin off decision by measuring parameters like growth in terms of market
share and increase in revenues, profitability in terms of stock price returns,
EPS, Market Capitalization etc. Additional factors like capital structure,
leverage ratios can be analyzed as well. The parameters would be quantified via
a normal distribution for different companies.
Outcome of Research
The research outcome would entail how spin-offs can be expected
to increase value. Additionally, what boards and management of corporate take to
consider both the short-term and long-term value benefits of separations. The
different parameters considered in the study will help conclude whether spin
offs do generally result in profitability for the company or there are more
factors pertaining to its success. While spin-offs have undoubtedly created
shareholder value, a careful cost-benefit analysis is still necessary before a
spin-off decision is made. The research would help different companies to take
decisions pertaining to take potential carve outs of the parent structure and
Berger, P.G. and Ofek, E. (1995). Diversification’s effect
on firm value. Journal of Financial Economics, 37, 39-65.
“Learning About Internal Capital Markets from Corporate
Spinoffs” – Robert Gertner, professor of economics and strategy at the
University of Chicago’s Graduate School of Business, and David Scharfstein,
professor of management at MIT’s Sloan School of Management
Marc Zenner, Evan Junek and Ram Chivukula, J.P. Morgan. Shrinking
to Grow: Evolving Trends in Corporate Spin-offs, Journal of Applied Corporate
Mary Kwak. Spinoffs
Lead to Better Financing Decisions, MIT Sloan Management Review, 2001
Andrew Campbell, How
Separate Should a Corporate Spin-Off Be? – Harvard Business Review, 2014
Daley, L., Mehrotra,
V. and Sivakumar, R. (1997), Corporate focus and value creation: Evidence from
spinoffs. Journal of Financial Economics, 45, 257-281.
Desai, H. and Jain,
P.C. (1999). Firm performance and focus: long-run stock market performance
following spinoffs. Journal of Financial Economics, 54, 75-101.
Press Release of
Canadian Pacific (2001). “Canadian Pacific to enhance shareholder value by
spinning off its businesses”.
and Enrico Polastro, How to Know If a Spin-Off Will Succeed. Harvard Business
Financial Times 2015, “BHP