Do Corporate Spinoffs Lower Cost of Equity?

44 Pages Posted: 27 Jan 2004

See all articles by Ranjan D'Mello

Ranjan D'Mello

Wayne State University - Department of Finance

Sudha Krishnaswami

University of New Orleans - College of Business Administration

Patrick J. Larkin

Fayetteville State University-School of Business and Economics

Abstract

We empirically examine whether the elimination of negative synergies, the reduction of internal capital market inefficiencies, and the mitigation of information problems following spinoffs lower cost of equity. The results indicate that there is no decrease in the cost of equity in the full sample, which suggests that the gains around spinoffs are primarily a consequence of improvements in cash flow and operating performance rather than a decline in systematic risk or the cost of equity. However, we find a positive relation between the spinoff gains and a decrease in the cost of equity for the subsample of firms with high information asymmetry, and for the subsample of non-focus-increasing spinoffs shown in prior studies to have no improvements in future cash flow or operating performance. For firms with high information asymmetry, the relation between the spinoff gains and the decline in cost of equity is attributable to a decline in the cost of equity of the post-spinoff parent entity. The results indicate that spinoffs facilitate a decrease in adverse selection costs, and this is especially value enhancing for the parent firms, which are higher growth and more reliant on external capital.

Suggested Citation

D'Mello, Ranjan and Krishnaswami, Sudha and Larkin, Patrick J., Do Corporate Spinoffs Lower Cost of Equity?. Available at SSRN: https://ssrn.com/abstract=492962 or http://dx.doi.org/10.2139/ssrn.492962

Ranjan D'Mello

Wayne State University - Department of Finance ( email )

2771 Woodward Ave
Mike Ilitch School of Business
Detroit, MI 48201
United States
313-577-7828 (Phone)

Sudha Krishnaswami (Contact Author)

University of New Orleans - College of Business Administration ( email )

2000 Lakeshore Drive
New Orleans, LA 70148
United States
504-280-6488 (Phone)
504-280-6397 (Fax)

HOME PAGE: http://www.uno.edu/~skrishna

Patrick J. Larkin

Fayetteville State University-School of Business and Economics ( email )

Fayetteville State University
Department of Managerial Economics and Finance
Fayetteville, NC 28301
United States
910-672-1067 (Phone)