The Value of Tunneling: Evidence from Master Limited Partnership Formations

Abstract

Shareholders of publicly-traded subsidiaries are potentially susceptible to expropriation (tunneling) by parent companies (Atanasov, Boone, and Haushalter, 2010). Recent study suggests that this could be particularly true among U.S. master limited partnerships (“MLPs”), where there is often substantial divergence between the control rights and cash-flow rights of parent firms, through their general partner interests (Atanassov and Mandell, 2018). Although the negative impact of tunneling on controlled firms is documented in the literature, little is known about the valuation consequences of tunneling for parent corporations. Changes to the MLP agency environment over the prior two decades—namely, the allowance of modifications to fiduciary duty and the introduction of incentive distribution rights—have likely increased the incentive and opportunity for tunneling, and provide a rich setting for addressing this question. Using a sample of MLPs formed from corporate assets, I examine the effects of changing tunneling incentives on stock returns of parent corporations announcing the formation of MLPs. I document significantly higher announcement period returns for MLP formations after these changes, which, in concert with additional testing, suggests that parent corporation shareholders benefit from the increased ability to tunnel the assets of the MLP.

Keywords: Master Limited Partnerships, Tunneling, Equity Carve-Out, Agency Problems

JEL Classification: G14, G34, H25, K12, M41