Do Spin-offs Expropriate Wealth from Bondholders?

Authors

  • William F. Maxwell,

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    • Maxwell is with the University of Arizona. Rao is with Oklahoma State University. We are particularly grateful to the anonymous referee whose suggestions significantly improved the paper. We would like to thank seminar participants at Georgetown University, George Washington University, the University of Georgia, Oklahoma State University, Southern Methodist University, Texas Tech University, Virginia Tech, and William and Mary for helpful comments and suggestions. We also thank Ro Gutierrez, Jim Linck, Erik Lie, Dave Mauer, Allan Eberhart, Kumar Venkataraman, John Polonchek, Tom Gosnell, Bill Elliott, Tim Krehbiel, and Dave Carter for suggestions that improved the paper. Special thanks go to Martin Fridson, Merrill Lynch, and Mark Shenkman and Mark Flanagan, Shenkman Capital Management, for their insights and perceptions into how bondholders view and react to spin-offs. This paper was initiated while both authors were affiliated with Texas Tech University. We thank the Wayne and Gladys Valley Foundation for a research grant to obtain data for the study. Finally we would like to thank Keldon Bauer, Mark Swanstrom, Moe Sann, and Vusal Najafov for able research assistance.
  • Ramesh P. Rao

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    • Maxwell is with the University of Arizona. Rao is with Oklahoma State University. We are particularly grateful to the anonymous referee whose suggestions significantly improved the paper. We would like to thank seminar participants at Georgetown University, George Washington University, the University of Georgia, Oklahoma State University, Southern Methodist University, Texas Tech University, Virginia Tech, and William and Mary for helpful comments and suggestions. We also thank Ro Gutierrez, Jim Linck, Erik Lie, Dave Mauer, Allan Eberhart, Kumar Venkataraman, John Polonchek, Tom Gosnell, Bill Elliott, Tim Krehbiel, and Dave Carter for suggestions that improved the paper. Special thanks go to Martin Fridson, Merrill Lynch, and Mark Shenkman and Mark Flanagan, Shenkman Capital Management, for their insights and perceptions into how bondholders view and react to spin-offs. This paper was initiated while both authors were affiliated with Texas Tech University. We thank the Wayne and Gladys Valley Foundation for a research grant to obtain data for the study. Finally we would like to thank Keldon Bauer, Mark Swanstrom, Moe Sann, and Vusal Najafov for able research assistance.

Abstract

A wealth transfer from bondholders to stockholders is one of several hypotheses used to explain stockholder gains on the announcement of a spin-off. However, previous empirical research has not found systematic evidence supporting the wealth expropriation hypothesis. Using a larger sample with comprehensive bond data, we find evidence consistent with wealth expropriation. Bondholders, on average, suffer a significant negative abnormal return during the month of the spin-off announcement. However, even accounting for the loss to the bondholders, the aggregate value of the publicly traded debt and equity increases on a spin-off announcement, suggesting that the wealth expropriation hypothesis is not a complete explanation of the stockholder gains. In explaining the magnitude of the losses to bondholders, we find they are a function of the loss in collateral in the spun-off subsidiary and the level of financial risk of the parent firm. Consistent with a loss to bondholders, firms are more likely to have their credit rating downgraded than upgraded after a spin-off. Additionally, consistent with the wealth transfer hypothesis, losses to bondholders tend to be more severe, the larger the gains to shareholders.

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