Information Asymmetry and the Market Reaction to Equity Carve-Outs

Abstract

In this paper, I test whether, following an equity carve-out, there is a reduction in information asymmetry among investors of the parent firm, and whether this reduction is value-enhancing. I measure information asymmetry by estimating the probability of information-based trading (PIN) using a sequential trade microstructure model [developed by Easley, Kiefer, and O'Hara (1996)]. Consistent with my hypothesis, the results show a significant decline in the average PIN for the sample firms after equity carve-outs. In addition, I find no significant change in the average PIN for an industry-, size- and exchange-matched control sample of firms. Further, for the carve-out sample, the estimated rates of both informed and uninformed trading increase significantly after carve-outs, and the probability of occurrence of a private information event reduces after carve-outs. I also find that the decline in PIN is more pronounced when the carve-out is intended to refocus the parent's operations and when no segment disclosures are made by the parent prior to the carve-out. Finally, consistent with the information hypothesis, I find that gains around equity carve-out announcements are positively related to the level of pre-carve-out informed trading.

Keywords: equity carve-outs, market microstructure, information asymmetry, informed trading, high frequency data

JEL Classification: C1, D4, D8, G3