Learning About Internal Capital Markets from Corporate Spinoffs

Abstract

This paper examines the investment behavior of firms before and after they are spun off from their parent companies. We show that investment after the spinoff is significantly more sensitive to measures of investment opportunities (e.g. industry Tobin's Q or industry investment) than it is before the spinoff. Spinoffs tend to cut their investment in low Q industries and increase their investment in high Q industries. These changes are observed only in spinoffs of firms in industries unrelated to the parents' industries and in spinoffs where the stock market reacts favorably to the spinoff announcement. Our findings point to the possibility that one effect of spinoffs is to improve the allocation of capital.

JEL Classification: G31,G34