Information Asymmetry, Valuation, and the Corporate Spin-Off Decision

Abstract

We analyze information-related motivations for why firms divest divisions through spin-offs. The information hypothesis argues that the separation of a firm's divisions into independently traded units through a spin-off improves market valuation by mitigating information asymmetry about the firm. The evidence is consistent with this hypothesis. Using five different measures of information asymmetry, we find that firms that engage in spin-offs have higher levels of information asymmetry prior to the spin-offs compared to their industry and size matched counterparts. Further, the information problems decrease significantly after the spin-offs. Extant literature argues that by separating unrelated divisions, spin-offs mitigate negative synergies between divisions and improve the focus in firms' operations. Consistent with this view, we find that the likelihood of a spin-off is increasing in the level of information asymmetry and the level of diversification in firms. This evidence also suggests that spin-offs may be partially anticipated by the market. We therefore compute the anticipation-adjusted announcement period abnormal returns to capture the total gains from a spin-off. The results indicate that when firms spin off related subsidiaries, i.e., when firms separate divisions where negative synergies are less likely, information-related motives are especially important in explaining the anticipation-adjusted abnormal returns. Finally, firms that have higher growth opportunities and firms that are in need of external capital show a higher propensity to engage in spin-offs, even though spin-offs themselves generate no new capital for the firms. They raise more capital following a spin-off, which is consistent with the view that these firms mitigate information asymmetry before approaching the capital market for funds.

Note: This is a description of the paper and is not the actual abstract.

JEL Classification: G34, D82