The Effect of Transaction Structure on Price: Evidence from Subsidiary Sales

Abstract

We analyze the effect of tax-based transaction structure on the acquisition price of corporate subsidiaries. For a sample of 200 subsidiary stock acquisitions, the evidence weakly supports the conclusion that acquisition premiums are higher in transactions accompanied by an I.R.C. section 338(h)(10) election. Specifically, purchase prices, as manifested in accounting acquisition multiples are higher in subsidiary stock sales accompanied by the section 338(h)(10) election than in subsidiary stock sales made in the absence of the election, but not uniformly so. We also find that divesting parent abnormal stock returns are higher in subsidiary stock sales in which the section 338(h)(10) election was made than in those deals in which the election was not made. Further, we find that the tax benefits generated by the section 338(h)(10) election are positively correlated with divesting parent abnormal stock returns. Finally, a review of corporate disclosures made by acquirers and divesting parent firms in subsidiary stock sales provides compelling anecdotal evidence that acquirer's pay a premium to sellers for the tax benefits derived from a section 338(h)(10) election. Overall, this study indicates that the tax structure of a subsidiary sale influences the price paid in the transaction, and the tax structure selected is a function of a divesting parent's tax basis in the subsidiary's stock and net assets.

Key Words: Taxes; Valuation; Mergers; Acquisitoins; Divesitures

JEL Classification: H25, G34