On the acquisition of equity carve-outs

Journal of Banking & Finance 35 (2011) 3432–3449

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On the acquisition of equity carve-outs Chintal A. Desai a,⇑, Mark S. Klock b, Sattar A. Mansi c a

Department of Economics and Finance, College of Business Administration, The University of Texas-Pan American, 1201 West University Drive, Edinburg, TX 78539-2999, USA Department of Finance, School of Business, The George Washington University, 2201 G. Street, NW, Washington, DC 20052, USA c Department of Finance, Insurance, and Law, Pamplin College of Business, Virginia Tech, Blacksburg, VA 24061, USA b

a r t i c l e

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Article history: Received 18 January 2011 Accepted 30 May 2011 Available online 12 June 2011 JEL classification: G34 G32 Keywords: Equity carve-outs Acquisition Parent–subsidiary Corporate restructuring

a b s t r a c t We examine the role played by the parent’s motive in undertaking a carve-out; the parent’s post-IPO influence over the carved-out subsidiary; and anti-takeover provisions and industry structure of a carve-out on its acquisition likelihood and its acquisition premium. We find that the probability and hazard of a carve-out acquisition increase when the parent’s objective is to unlock the value of a subsidiary and when the parent and the subsidiary are tied with a product-market relationship. We also find that the post-IPO parent ownership significantly affects the acquisition likelihood and the level of acquisition premium. Additional analyses examining the post-IPO carve-out status suggest that the product-market relationship and post-IPO parent ownership increase the probability of re-acquisition. Ó 2011 Elsevier B.V. All rights reserved.

1. Introduction An equity carve-out (ECO) is a form of corporate restructuring whereby the parent firm offers a subset of its subsidiary’s common shares to the public.1 Research evidence indicates that ECOs are temporary arrangements for the parent firms and the majority of ECOs are acquired within a few years after their initial public offerings (IPOs).2 In such a scenario, do we know a priori the factors which can predict the eventual acquisition of an ECO? And do these factors have an impact on the ECO shareholders’ wealth, when it actually gets acquired? To our knowledge, these questions have not been explored in the corporate restructuring literature and we attempt to fill this gap. Specifically, we analyze the effects of: the parent’s motive for conducting a carve-out; parental control on the post-IPO carve-out; anti-takeover provisions in the charter of a carve-out; and industry structure of the carve-out on the likelihood of an acquisition and the level of acquisition premium. Within the likelihood of acquisition, we look into the probability of acquisition and the hazard of acquisition. We also assess the impact of our chosen variables on the subsamples of ECOs that are either re-acquired by the parent firm or acquired by a third-party.

⇑ Corresponding author. Tel.: +1 956 665 7358; fax: +1 956 665 5020. E-mail addresses: [email protected] (C.A. Desai), [email protected] (M.S. Klock), [email protected] (S.A. Mansi). 1 For a review on ECOs and other forms of corporate restructuring, see Eckbo and Thorburn (2008). 2 For example, Klein et al. (1991) show that 44 of 52 ECOs in their sample are either re-acquired or sold off to a third-party by the parent firms. 0378-4266/$ - see front matter Ó 2011 Elsevier B.V. All rights reserved. doi:10.1016/j.jbankfin.2011.05.021

The prior work of other scholars facilitates our research endeavors. For example, Perotti and Rossetto’s (2007) theoretical model implies that the likelihood of an ECO acquisition increases when the parent’s motive for conducting a carve-out is to unlock the value of its subsidiary. As per the authors, prior to the carve-out, the parent is unaware of the ‘‘fair’’ value of its synergy with the subsidiary, which precludes it from making an informed decision to keep either full or no ownership in the subsidiary. Subsequent to the carve-out, market participants assist the parent firm in ascertaining the value of its synergy with the subsidiary. If the synergy is positive, then the parent firm decides to re-acquire the carvedout subsidiary, else if the synergy is negative, then the parent decides to sell it off to a third-party. Based on the authors’ insights, we posit that, if the parent’s motive is to unlock the value of its subsidiary, it is likely to be interested in determining its synergy with the subsidiary. Therefore, this carved-out subsidiary’s acquisition is imminent, either by the parent itself or by a third-party. An equity carve-out differs substantially from other forms of corporate restructuring such as spinoffs and asset sales in terms of the post-divestiture parent role in the subsidiary.3 Allen and McConnell (1998) show that, on average, the parent retains 69% of 3 In spinoffs, the parent firm distributes its ownership in the subsidiary on a prorata basis to its existing shareholders, whereas in the case of an asset sale, the parent firm sells its ownership in the subsidiary to a third-party on a private negotiation basis. In both cases the parent retains no ownership in the post-divesture subsidiary, suggesting minimal parent control. However, a few papers show the significant role of the parent in the spun-off subsidiary. For example, Wruck and Wruck (2002) show the involvement of the parent in appointing the top-management team of the spinoff.

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the ownership in the subsidiary. The ownership in an ECO provides required voting rights to the parent, which allows it to appoint its nominee on the board and on the audit committee of the carveout.4 The parent firm, generally, appoints its past employees to key executive positions of the carve-out. In addition, prior to a carveout transaction, a parent can sign long-term business agreements with the subsidiary, which allows it not only to preserve the existing synergy but also to exert undue influence over the subsidiary.5 We hypothesize, as explained in Section 2.2, that the post-IPO parental control can have an effect on the ECO’s acquisition. The anti-takeover provisions and the industry in which an ECO operates can also play a role in its acquisition. Field and Karpoff (2002) find that the probability of acquisition of an IPO decreases when it employs takeover defenses in its charter. Takeover defenses might also affect the level of acquisition premium; though the evidence is mixed. For example, Megginson (1990) finds an increase in premium for firms with anti-takeover provisions, while Field and Karpoff (2002) do not find any significant relation between the level of premium and anti-takeover provisions. Regarding the relevance of the industry, Perotti and Rossetto (2007) conjecture that ECOs operating in high-technology (hi-tech) industries have a longer time-to-acquisition due to a higher level of valuation uncertainty in those industries. In contrast, hi-tech firms also offer changes in technology and above-market returns which can increase the probability of their acquisition (Kohers and Kohers, 2000). Using a sample of 222 equity carve-outs (of which 137 are acquired) for the period of 1986–2004, we find that the likelihood of acquisition increases when the parent’s motive for undertaking an ECO is to unlock its value, when the parent retains majority ownership in the post-IPO carved-out subsidiary, and when the parent and the subsidiary are tied with product-market relations. We also find some evidence that when the ECO operates in the hi-tech industry, the likelihood of acquisition increases. Further, we find an inverse relation between the level of acquisition premium and whether the parent ownership in the ECO is above 50% prior to the acquisition. In terms of the differences between the parent re-acquisition and a third-party acquisition, we find that the probability of re-acquisition increases when the parent’s motive is to unlock value, when the parent retains majority ownership in the post-IPO carve-out, and when the parent and ECO have an ongoing product-market connection. Our results are robust to self-selection and endogeneity issues. Michaely and Shaw (1995) find that the bigger and less profitable parent firms are likely to divest their subsidiaries by conducting carve-outs instead of spinoffs. This choice of going public in the first place is likely to induce self-selection bias in our estimation. To address this, we perform a two-stage Heckman analysis for the probit models. In the first stage, we analyze the choice between a carve-out and a spinoff, and in the second stage, given that the parent has selected to perform an ECO, we analyze its likelihood of acquisition. In terms of endogeneity, the parent might be anticipating the ECO’s future acquisition at the time of consummating the carve-out transaction, and accordingly decides the post-IPO ownership in the carve-out. In that case, the retained ownership in the carve-out is likely to be endogenously determined. We address this issue by performing an 4 Throughout the paper, the term ownership refers to the voting ownership rather than cash flow ownership since the former can have a significant impact on the acquisition event. The difference between the two is relevant only for equity carveouts with dual class shares. 5 The long-term agreements with the parent firm can prevent an ECO from obtaining a better deal in an arm’s-length transaction. For example, the Appendix of Atanasov et al. (2010) provides the case of Coca-Cola’s (KO) influence over its partially-owned (49% ownership) subsidiary Coca-Cola Enterprises (CCE) through long-term business agreements.

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instrumental variable probit analysis and bivariate probit analysis, which are similar to that of a two-stage least squares analysis. In the first stage, we explain the parent’s post-IPO ownership in a carve-out, and in the second stage, we use the predicted value of the parent retained ownership for explaining the probability of an acquisition. We do not report these results in this paper to economize on space, but they are available in Desai et al. (2011). Our paper contributes to the corporate restructuring literature in at least four ways. First, we undertake a comprehensive study by collectively analyzing the IPO and acquisition events of a carve-out.6 Second, we assess the likelihood of acquisition of carve-outs by analyzing the probability and the hazard of acquisition. The latter part, to our knowledge, has not been investigated. Third, we explore the impact of contributory factors, other than the parent retained ownership, such as the parent motives for conducting a carve-out, parent–subsidiary business relations, anti-takeover provisions, and the industry in which the carve-out operates on the carve-out’s acquisition. Lastly, we explain differences in the likelihood of acquisition and the acquisition premium for the subsamples of parent re-acquisitions and third-party acquisitions. The remainder of the paper is organized as follows: Section 2 illustrates our hypotheses, and Section 3 highlights the data, variable measurements, and descriptive statistics. Section 4 provides the empirical results. Section 5 concludes the paper. 2. Hypotheses development 2.1. Reasons for conducting a carve-out and its acquisition When conducting a carve-out, the parent firms incur a substantial amount of explicit costs such as legal, underwriting, and filing fees. They also underprice in order to successfully consummate the offering; Hogan and Olson (2004) show a first-day return of 13%. In addition, there are costs due to the ‘disincentive’ effect (Perotti and Rossetto, 2007). Before a carve-out, the operating profits of the wholly-owned subsidiary belong entirely to the parent firm. After a carve-out, the parent firm incurs costs in operating the partially-owned subsidiary, but the profits are pro-rata distributed to the shareholders which also include minority shareholders. Then, what are the benefits for the parent firm in conducting an equity carve-out? Schipper and Smith (1986) describe three main reasons for conducting a carve-out: financing, restructuring, and unlocking the value. The financing reason involves the instances when the parent conducts an ECO to finance its own or its subsidiary’s growth projects, to discharge parent debt, or to raise funds to meet capital expenditure requirements. The restructuring reason involves the instances when the parent carves out the subsidiary to gain from the divestiture.7 Finally, the unlocking the value reason involves the cases when the parent undertakes an ECO for investors to better understand the operations of the carve-out. At the time of an IPO and subsequent to it, the subsidiary needs to comply with the Securities and Exchange Commission (SEC) by filing forms such as registration statements, proxy statements, 10-Ks, and annual reports. From these 6 Several studies seek to establish a link between the IPO and the acquisition events of a carve-out. For example, Klein et al. (1991) show that the probability of reacquisition increases with the increase in post-IPO parent ownership. Hulburt (2003) finds that the parent firms of the ECOs that were subsequently acquired experience greater wealth gains at the time of carve-out announcements. Otsubo (2009) shows that the market participants anticipate a third-party acquisition and accordingly adjust the share price of the parent on a carve-out announcement. 7 The divestiture gains hypothesis posits that the carve-outs help the parent firms improve investment efficiency, focus on their core businesses, and reduce agency costs by aligning managers’ and shareholders’ interests through writing effective contracts (Hulburt et al., 2002; Vijh, 2002).

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filings, the investors can obtain the relevant information about the carved-out subsidiary. As mentioned earlier, the theoretical insights of Perotti and Rossetto (2007) help establish a possible linkage between the parent motive at the time of a carve-out and the subsequent acquisition of the carve-out. They argue that the status of a subsidiary as a fully-integrated and an independent identity are two extremes, and it depends on the synergy between the parent and the subsidiary. By selling out full ownership in a subsidiary, the parent firm carries an irreversible loss if it finds a positive synergy with the subsidiary in the future. At the same time, by keeping the subsidiary fully-integrated, the parent firm is unable to assess the value of the synergy. An ECO of the subsidiary provides the parent a better alternative. On the one hand, carving out the subsidiary at the first stage causes the parent firm to incur costs related to the public issue and the loss of operational efficiency. On the other hand, it helps the parent firm determine the value of its synergy with the subsidiary more accurately while retaining control (through a majority ownership) in the subsidiary. Therefore, the carve-out of a subsidiary provides the parent firm with an indefinite American style option to buy back the remaining ownership from the minority shareholders or to sell out its ownership to a third-party. The exercise of this option depends on the value of the underlying synergy between the parent and subsidiary. These synergies (operational, financial, etc.) can be positive or negative. The positive value of the synergy indicates that the parent is better off by keeping 100% ownership in the carved-out subsidiary. Thus, the parent can achieve synergistic gains such as lower transaction costs than what it would gain in arm’s length transactions, and it can avoid losses due to the ‘disincentive’ effect. The negative value of the synergy implies that the parent is better off by removing the carved-out subsidiary from its portfolio. Therefore, the parent may decide to sell its ownership to a third-party. We conjecture that if the parent’s motive is to unlock the value of a subsidiary, then its intentions are likely to ascertain its synergy with the subsidiary, and it would like to possess the real option of re-acquiring or selling off the remaining portion of the subsidiary. Therefore, our first hypothesis is: H1. The parent’s motive of unlocking the value of the subsidiary suggests a higher likelihood of the ECO’s acquisition.

2.2. Post-IPO parental control and the acquisition of a carve-out In this subsection, while forming the hypothesis on the relationship between the post-IPO parental control and the acquisition of the carved-out subsidiary, we mainly refer to two mechanisms by which the parent can exert its undue influence over the carve-out. These are parent retained ownership and its ongoing business connections with the carve-out. The parent firm obtains a real option to re-acquire or to sell off the remaining portion by retaining the majority ownership in the carved-out subsidiary (Perotti and Rossetto, 2007). The majority ownership also helps the parent firm obtain the approval of the ECO board with less effort should it decide to re-acquire the subsidiary, because through majority ownership the parent can appoint its nominees to the carve-out’s board. Even in the case of a third-party acquisition, the bidder effectively needs to convince only one shareholder (the parent firm) to tender shares, which increases the likelihood of acquisition. In addition, majority ownership creates less-dispersed ownership in the carve-out, which helps mitigate the free-rider problem as pointed out in Grossman and Hart (1980). Majority ownership also allows the parent firm to appoint its past employees to

the key management positions in the carve-out. These top executives can potentially affect the outcome of a major corporate event such as acquisition. Therefore, the majority ownership in a post-IPO carve-out suggests an increase in the likelihood of a carve-out’s acquisition. Further, the property rights theory of Grossman and Hart (1986) and Hart and Moore (1990) suggests that when Company A and Company B have a business relationship and Company A has incentives to control assets and resources of Company B, then Company A will maintain ownership in Company B. For ECOs, based on the predictions of the property rights theory, Boone (2003) finds that the parent firms maintain high ownership in carve-outs if they have a product-market or financial relationship. Therefore, we conjecture that if the parent and subsidiary are linked through longterm business relationships such as product-market and financial, then the parent firms are likely to retain majority ownership in the subsidiary which will increase its likelihood of acquisition. Therefore, our second hypothesis is: H2. Majority ownership by the parent firm in the post-IPO carveout and ongoing business connections between the parent and the ECO increase the likelihood of acquisition of the ECO. The parent through its control over the subsidiary can impact the level of acquisition premium. In the case of re-acquisitions, it is reasonable to claim that the parent may expropriate wealth of the minority shareholders. However, the incentive to expropriate minority shareholder wealth will be weaker when the parent retains a larger fraction of the ECO because a smaller fraction of any premium paid will accrue to the minority shareholders.8 Additionally, the parent firm’s re-acquisition bid needs to be approved by a special committee of independent directors who do not have any vested interest with the parent firm. Therefore, the difference in the acquisition premium between a third-party acquisition and a parent re-acquisition might be insignificant. Indeed, prior empirical findings suggest mixed views. On the one hand, Slovin and Sushka (1998) analyze a sample of parent–subsidiary mergers that also includes mergers of equity carve-outs. As per their study, for the period 1970–1993, the subsidiary announcement day return is 19% for 105 parent re-acquisitions; whereas that statistic is 21% for 38 third-party acquisitions, and the difference between the two is statistically insignificant. On the other hand, Atanasov et al. (2010) show the instances when the parent firms deliberately transfer risk to the publicly-traded subsidiaries and expropriate wealth from the minority shareholders. These mixed findings preclude a decisive hypothesis about the minority wealth expropriation in the case of equity carve-outs, and we rely on our data and analyses to guide us on this. 2.3. Anti-takeover provisions in a carve-out and its acquisition Managers adopt anti-takeover provisions in the charter of a firm mainly to avoid the external market for corporate control.9 Ambrose and Megginson (1992) show that the probability of acquisition decreases when the firm uses blank-check preferred stock – a form of an anti-takeover provision. Megginson (1990) reports that the trading price and the acquisition premium of the superior voting shares are higher than those of the otherwise equivalent class of restricted voting shares. In the case of IPOs, Field and Karpoff (2002) show that the probability of acquisition of an IPO decreases when it has anti-takeover provisions in its charter at the time of the IPO. Therefore, our next hypothesis is: 8

We thank the referee for bringing this important point to our attention. For a review on different forms of anti-takeover provisions, see Gompers et al. (2003). For the impact of anti-takeover provisions on the performance of a spin-off parent firm, see Chemmanur et al. (2010). 9

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H3. Anti-takeover provisions in the charter of an ECO decrease the likelihood of its acquisition, and increase the level of acquisition premium.

3. Data and variables 3.1. Data description We obtain the initial sample of 619 equity carve-outs, offered over the sample period of 1986–2004, from the Security Data Corporation (SDC)’s new issues database and issues of the ‘Mergers and Acquisitions’ magazine.10 From this sample, we eliminate carve-outs for which parents/carve-outs are mutual trusts, limited partnerships, foreign firms, finance firms, limited liability firms, and joint venture firms. We also exclude observations which are unit offerings, target stocks, spinoffs, and for which data are missing from the Center of Research in Security Prices (CRSP) tapes for the parent/carve-out. This screening reduces our sample to 295 carve-outs. Finally, we eliminate carve-outs for which the parent firms have already announced plans to divest their remaining ownership11 (44 carve-outs) and the data are missing in the (Q-data) microfiche (29 carve-outs). This yields a final sample of 222 carve-outs from 199 parent firms. It contains wholly-owned (163 carve-outs) and partially-owned (59 carve-outs) subsidiaries. For each carve-out, we collect the parent firm’s reason for conducting a carve-out from news articles in LexisNexisÒ. The ownership, board composition, top management team, and business relationship data are from SEC filings including proxy statements, 10-Ks, and prospectuses. We collect merger announcement dates and merger related details such as offer price, exchange ratio, and winning bidder from news articles in LexisNexisÒ and FactivaÒ, and available proxy statements before the acquisition. In order to avoid errors due to discrepancies in the Standard Industrial Classification (SIC) codes in the Compustat and CRSP databases (Kahle and Walkling, 1996), we collect SIC codes primarily from LexisNexisÒ and SEC filings, and the missing ones from SDC, Compustat, and CRSP, in that order. We obtain offer size data from FactivaÒ, SEC filings, and SDC. Finally, we extract data on the time-to-acquisition, size of the carve-out, and size of the parent firm from CRSP. 3.2. Dependent variables For the logit analysis on the probability of acquisition, we follow Field and Karpoff (2002) and assign a value of one to a carve-out that was acquired within 5 years from its IPO date, and zero to a survived one. For the hazard analysis, we define Acquisition Time as the number of months between the last and the first trading dates of a carve-out as given in CRSP. For carve-outs which are actively traded as of December 31, 2007, we take this date as the last available trading date. For the analysis on acquisition premium, we use three approaches to compute the level of premium. First, we consider the possibility of an information leakage prior to the merger announcement (Schwert, 1996). The variable Acquisition Premium_42 is the ratio of the price offered per share of a carve-out to the carve-out’s price per share on the 42nd trading day prior to the merger announcement, minus one. For the stock-to-stock exchange, we compute the carve-out offer price using the available exchange ratio and the bidder’s price on the announcement day. 10 The cutoff year of 2004 allows us to follow all carve-outs for at least a three-year period, which provides sufficient time for parents to fully divest or re-acquire their subsidiaries should they choose. 11 In these cases, the parent firms generally announced plans to divest their remaining portion within a year of IPO by tax-free spinoffs. For more on such carveout/spinoff combination transactions, see Thompson and Apilado (2006).

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For five acquired carve-outs, since we do not find the price on the 42nd trading day prior to the announcement, we use the price on the sixth trading day prior to the announcement. For the second and the third approach of computing the acquisition premium, we follow Moeller (2005). We define Acquisition Premium_Returns as the buy and hold (excess) return during the merger announcement date. Specifically, we compute the carveout’s buy and hold return for 11 trading days starting with the five trading days prior to the merger announcement and subtract the buy and hold return on the CRSP value-weighted index for the same time period. Finally, we define Acquisition Premium_06 which is similar to Acquisition Premium_42, except that we compute the ECO price on the sixth instead of 42nd trading day prior to the merger announcement. 3.3. Explanatory variables We group our explanatory variables into five sets of variables. The first set pertains to the motive of the parent firm to undertake an equity carve-out. The second set consists of factors through which the parent can exert control over the post-IPO carve-out. The third category contains our proxies for the anti-takeover provisions in a carve-out and its industry structure. The fourth category represents the set of control variables. Finally, the fifth category contains the set of variables which are related to a merger transaction. The variable definitions, their detailed description, and the data sources are available in Appendix A. 3.3.1. Factors related to the parent motive We extensively review the news reports at the time of the IPO announcements and identify three categories of reasons for conducting an equity carve-out. These are financing/investing, restructuring, and unlocking the value.12 These are not mutually exclusive categories due to the cases when the parent provides multiple reasons for conducting a carve-out. There are also other instances when the reason for conducting a carve-out does not fall into any of these three categories, for example, the reason of conducting a carve-out due to apartheid concerns or to meet government regulations on an antitrust lawsuit; we note these cases under the other category. First, if a parent undertakes a carve-out for general corporate purposes, for working capital, for repayment of debt, for capital expenditures, for possible acquisitions, or for taking out the parent from financial distress, we consider these instances in the financing/investing category. Second, we define the restructuring reason as the instances when the parent consummates the carve-out transaction to focus on core business or as part of a larger restructuring plan. Finally, the category of unlocking the value consists of the cases when the parent undertakes a carve-out to create a liquid market for the subsidiary shares, to allow the market to value the subsidiary, or to create a liquid market for employee shareholders.13 3.3.2. Factors related to the post-IPO parental control over the carveout We study the parental role in the post-IPO carve-out via equity ownership, board and audit committee composition, top-management team, and long-term business relationships. The most direct way the parent firm can exert control over the ECO is by retaining majority ownership. We also define the reduction in parent owner12 For more detailed examples of the language used by parent firms when they announce carve-outs for unlocking the value, see Desai et al. (2011), Chemmanur and Liu (2011), and Nanda and Narayanan (1999). 13 We also define the parent’s motive to unlock the value by considering only those announcements in which the parent undertakes an ECO to allow the market to value the subsidiary. Our results remain qualitatively similar with this definition.

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ship as the difference of parent ownership before and after the IPO; a smaller value of this variable indicates a higher level of parental control over the post-IPO carved-out subsidiary. To capture the non-linear relation between the parent ownership and our dependent variables, we consider two indicator variables reflecting whether the parent retains above 50% and above 80% ownership. The ownership allows the parent firm to appoint its personnel as directors and top-executives of the carve-out firm. Directors in the carve-out can be one of three types: insider, outsider, or parent representative. Parent representative directors are current or past employees of the parent firm. Following Boone (2003), we define the top-management team of a carve-out being affiliated with the parent firm if the chairman, CEO, or president of a carve-out is either a current or past employee of the parent firm. We also measure the parent influence over the audit committee of the carve-out by identifying whether any of the parent’s past or current employees serve on that committee. We define a product-market relation between the parent firm and the ECO when they have buyer–supplier, technology sharing and research and development, marketing and distribution, or specialized service agreements (Boone, 2003). Similarly, we define a financial relationship when the parent and the ECO are involved in a long-term financial agreement through letters of credit, bank guarantees, or term loans (Boone, 2003). We also consider industry relatedness of the parent and subsidiary to capture the possibility of parental involvement in the subsidiary if they both are in the same industry.

3.3.3. Factors related to anti-takeover provisions and industry structure of a carve-out We use three types of anti-takeover provisions. These are whether a carve-out has a staggered board, two classes of shares, and whether its state of incorporation is Delaware. We restrict our analysis to only three anti-takeover defenses due to unavailability of (a) IPO prospectuses for the ECOs prior to the year 1996 and (b) takeover defenses on standard databases such as the Investor Responsibility Research Center (IRRC) for an ECO firm because of its small size. Regarding the industry structure of a carve-out, we assign a dummy variable that takes on a value of one if the firm operates in the hi-tech sector (SIC code of 28, 357, 36, 38, or 737).14

3.3.4. Other control variables Governance related: We measure ownership of the CEO, insiders (executives and directors), and blockholders. Because ownership data are not reported when the insider/CEO owns less than 1% and the blockholder owns less than 5% of the outstanding shares, we use both continuous and indicator variables for insider/CEO and blockholder ownership. Regarding the directors other than the parent directors, insider directors are the employees of the carve-out but have no relationship with the parent firm. Outside directors are not the employees of the carve-out or of the parent firm. We measure board size as the number of directors immediately after the IPO. Board size is considered large when the number of directors is above the median board size. We capture the CEO power by measuring whether she is also a chairperson of the board. Size and performance related: We control for the relative size (ratio of the carve-out size to the parent firm size), IPO offer size, and carve-out stock market performance in our analysis. 14 We follow the definition of a hi-tech industry in Benou et al. (2008), who in turn rely on the SDC. An example of a hi-tech carve-out is Networth Inc. (SIC: 3577) which went public on 11/25/1992 and is in the business of computer peripheral equipments. Its parent, Tandem computers (SIC: 7377), also operates in a hi-tech industry.

3.3.5. Factors related to a merger transaction For analysis on the level of acquisition premium, we also control for variables that are related to a merger transaction. These are whether a lawsuit is filed during the merger process, the ratio of bidder size to target size, the carve-out size prior to its merger, whether more than one bidder attempts to acquire the carve-out, and whether the transaction is financed through only cash. All these factors are likely to impact the acquisition premium. 3.4. Descriptive statistics In Panel A of Table 1, we report the incidence of carve-outs based on offer year and post-IPO parent firm’s ownership. We classify carve-outs into three categories based on the CRSP delisting codes as of December 31, 2007: survived, acquired, and failed carve-outs. Survived carve-outs with a delisting code of 100 represent 18% of the sample and are still actively traded in the market. Acquired carve-outs with a delisting code between 200 and 290 represent 62% of the sample and are acquired by either the parent firm (22%) or a third-party (40%), and trading activities ceased after the acquisition date. Failed carve-outs represent the remaining 20% of the sample (46 carve-outs); of which 44 carve-outs are delisted (delisting code between 500 and 591), one is liquidated (delisting code between 400 and 490) and one is exchanged for another class of common stock (delisting code of 331). In terms of the year-wise distribution of the sample, the majority of ECOs are in the years 1996, 1991, and 1986, with 22, 21, and 20 carve-outs, respectively. The subsample of acquired ECOs display that 17, 15, and 14 transactions are in the years 1986, 1996, and 1987, respectively. In the period from 2001 to 2004, there are only seven carve-outs in our sample.15 We also examine the incidence of carve-outs for the parent ownership after the IPO. We divide the sample into three categories: those with post-IPO parent ownership less than 50%, between 50% and 80%, and more than 80%. The largest number of deals occurred in the ownership category between 50% and 80% (about 37%), followed by the greater than 80% category (about 34%), and the less than 50% category (about 29%). The parent firms retained majority (above 50%) ownership in 77% of acquired carve-outs, whereas, in survived carve-outs that statistic is only 49%. This difference of parent ownership in survived and acquired carve-outs suggests a possible relation between parent ownership and carve-out acquisition. Similar to the findings of Klein et al. (1991), 92% of the re-acquired carve-outs in our sample have parent ownership above 50%, which suggests that the probability of re-acquisition of carve-out increases with the post-IPO parent ownership. In Panel B of Table 1, we show the incidence of carve-outs and parent firms based on industry using two-digit SIC codes. Although there are 199 parent firms which conducted a total of 222 carveouts, for simplicity we consider a combination of one parent firm and one carve-out. The majority of the ECOs operate in the manufacturing industry (41%) and service industry (27%). Also, these industries significantly represent the acquired carve-outs sample with 41% and 31% of the sample, respectively. Based on our sample, 72% of the carve-outs operating in the service industry and 62% operating in the manufacturing industry are eventually acquired. Among the parent firms, 49% and 18% of sample firms operate in the manufacturing and service sectors, respectively. In Panel A of Table 2, we report summary statistics of variables pertaining to post-IPO parental influence on the carve-out and our chosen controls for the total sample. The parent ownership prior to 15 During this period, we exclude 13 observations of carve-out/spinoff combination in which the parents have already indicated the intent to divest their remaining portion.

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C.A. Desai et al. / Journal of Banking & Finance 35 (2011) 3432–3449 Table 1 Incidence of equity carve-out categories. Panel A: Equity carve-outs based on IPO offer year and parent ownership Survived Acquired

Failed

Total

17 14 4 6 3 10 10 7 9 6 15 11 7 9 9 0 0 0 0 137

3 4 2 1 0 8 4 2 1 2 5 3 1 5 3 1 1 0 0 46

20 18 8 8 4 21 15 13 15 12 22 18 12 16 14 2 3 1 0 222

32 53 52 137

13 24 9 46

65 82 75 222

By parent

By third-party

Sub total

0 0 2 1 1 3 1 4 5 4 2 4 4 2 2 1 2 1 0 39

5 7 2 1 1 5 0 3 2 3 5 5 4 1 4 0 0 0 0 48

12 7 2 5 2 5 10 4 7 3 10 6 3 8 5 0 0 0 0 89

Parent Ownership After IPO < 50% 20 P50% and <80% 5 P80% 14 Total 39

4 18 26 48

28 35 26 89

IPO Offer Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Total

Panel B: Industry classifications Industry Two-digit SIC range

Mining Construction Manufacturing Transportation & communication Wholesale trade Retail trade Services Others Total

Carve-outs Survived

Parent Acquired

Failed

By parent

By thirdparty

Total

Sub total

10–14 15–19 20–39 40–49

4 1 20 2

2 1 18 7

5 0 38 3

7 1 56 10

2 0 14 8

13 2 90 20

6 6 108 25

50–51 52–59 70–89 69 or P90

1 4 7 0 39

5 2 12 1 48

5 7 31 0 89

10 9 43 1 137

5 7 10 0 46

16 20 60 1 222

14 21 40 2 222

Notes: Panel A provides the frequency of carve-outs based on the IPO offer year and on the post-IPO parent ownership. We obtain the sample of equity carve-outs from the Security Data Corporation’s new issues database and the ‘Mergers and Acquisitions’ magazine. Based on the Center for Research in Security Prices (CRSP) delisting codes as of December 31, 2007, a given carve-out is classified as survived (delisting code 100), acquired (delisting code 200–290), and failed. Failed carve-outs are defined as those which are exchanged for another class of common stock (delisting code 331), are liquidated (delisting code 400–490), or are dropped (delisting code 500–591). The Standard Industrial Classification (SIC) codes are from LexisNexisÒ, SEC filings, SDC, Compustat, and CRSP, in that order.

the carve-out has a mean of around 95% and median of 100%, whereas parent ownership subsequent to the carve-out has a mean of 62% and median of 68%. The high post-IPO parent ownership in a carve-out suggests that the parent firm has an interest in controlling the subsidiary, which might not be possible through other forms of restructuring such as spinoffs and asset sales.16 The parent representative directors constitute, on average, 42% of the carve-out board, which indicates the possibility of the parent firm’s role in the operating and strategic decisions of a carve-out. Blockholder ownership has a mean of around 7%. Similarly, insider and CEO ownership 16 We also notice that in 13 out of 222 carve-outs the parent retained no ownership after the IPO of the subsidiary. In four of these carve-outs, the parent and subsidiary are tied through product-market agreements, and in none of these 13 carve-outs, the parent’s motive for undertaking a carve-out is to unlock the subsidiary’s value.

in a post-IPO carve-out on average are around 4% and 2%, respectively. The number of directors serving on the carve-out has a median of seven. The carve-out offer size has a mean of $174.5 million, a median of $48.5 million, and minimum and maximum values of $2.5 million and $8.7 billion, respectively. The median size of a carve-out is 22% that of the parent firm. For our sample firms, the average first year excess return over the value-weighted CRSP index return has a mean of 3.5%, which shows that in the short-run the ECOs tend to underperform. In Panel B of Table 2, we report summary statistics of dummy variables that proxy for the parent’s motive and its influence, anti-takeover provisions, industry structure and other control variables. In around 40% of our sample firms, the reason for conducting a carve-out is for financing related or for investment related activities. We also note that in around 11% of our sample firms the par-

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Table 2 Summary statistics for the total sample of equity carve-outs. Panel A: Descriptive statistics Variable Mean

Median

Std. Dev.

Min

Max

Post-IPO Parental Influence Parent Ownership Before 94.6 (%) Parent Ownership (%) 62.1 Parent Directors (%) 42.0

100.0

12.2

50.0

100.0

67.5 40.0

27.0 18.8

0.0 0.0

98.4 100.0

Other Control Variables Blockholder Ownership (%) Insider Ownership (%) CEO Ownership (%) Inside Directors (%) Outside Directors (%) Board Size Offer Size (in millions $) Size Ratio Performance (%)

0.0 1.3 0.0 12.5 44.4 7.00 48.50 0.22 18.7

12.0 7.1 7.6 12.5 17.1 2.27 648.02 0.78 73.5

0.0 0.0 0.0 0.0 0.0 3.00 2.50 0.00 114.5

57.2 58.9 95.0 60.0 83.3 20.00 8680.00 7.39 656.2

6.9 3.7 1.6 12.3 45.7 7.19 174.47 0.54 3.5

Panel B: Statistics of dummy variables Variable description Dummy = 1

% of sample

N

Parent’s Motive Financing Unlocking Restructuring

88 24 25

39.6 10.8 11.3

222 222 222

Post-IPO Parental Influence Parent Own P 50% Parent Own P 80% Parent on Audit Parent CEO Parent Chair Product Market Financial Same Industry

157 75 65 114 163 131 165 74

70.7 33.8 32.5 51.4 74.8 59.2 74.7 33.3

222 222 200 222 218 221 221 222

Anti-Takeover Provision Staggered Dual Class Delaware

90 39 180

40.5 17.6 81.1

222 222 222

69

31.0

222

83 120 59 124 91

37.4 54.1 26.6 55.9 41.4

222 222 222 222 220

Industry Structure Hi-Tech Other Control Variables Blockholder Own P 5% Insider Own P 1% CEO Own P 1% Large Board CEO Duality

Notes: Panel A shows the summary statistics of selected continuous variables. Data are primarily collected from proxy statements, 10-Ks, and prospectuses. For all variables, the number of observations (N) is 222. Panel B shows the descriptive statistics for the dummy variables used in this paper. Column 2 shows the number of carve-outs for which the concerned dummy variable equals one. That is, as shown in the first row, in 88 out of 222 carve-outs, the parent’s motive behind conducting a carve-out was financing/investing, which represents 39.6% of the total sample. Appendix A describes the variables in detail. N stands for number of carve-out firms.

ent conducts a carve-out to unlock the subsidiary’s value. In 157 out of 222 equity carve-outs, parent ownership is above 50%; the board-chairperson and CEO are associated with the parent firm in 75% and 51% of carve-outs, respectively. These numbers suggest the parent firm’s involvement in the operating and strategic decisions of the publicly-traded subsidiary. Regarding the business relationships, 59% of the carve-outs in our sample are linked to their parent firms through product-market agreements and 75% are linked through financial agreements. These statistics on business relationships suggest an alternative mechanism, other than ownership, by which the parent firm can control the subsidiary (Atanasov et al., 2010). In 33% of our sample firms, the ECO and parent have the same two-digit SIC code.

In our sample around 41% (18%) of ECOs use a staggered board (dual class shares). We also observe that 69 carve-outs operate in the hi-tech industry, representing 31% of our sample. Although the parent firms generally retain significant ownership in the ECO, we also observe a notable presence of blockholder, insider (executives plus directors), and CEO ownership in 37%, 54%, and 27% of our sample firms, respectively. Finally, in 91 out of 220 carve-outs, the CEO is also the chairperson of the board. Out of 222 carve-outs, we could not obtain data on audit committee, business relationship, chairperson’s affiliation with parent, and CEO duality for 22, one, four, and two carve-outs, respectively.17 In Table 3, we report statistics similar to those reported in Table 2 for the sample of acquired carve-outs. As shown in Panel A of Table 3, the mean and median time-to-acquisition are 69 and 54 months, respectively. The minimum and maximum time-to-acquisition is eight and 217 months, respectively. Out of 137 acquired carve-outs, 48 are re-acquired by the parent firm, and 89 are acquired by a third-party. The average and median time-to-acquisition in the case of parent re-acquisitions are 59 and 48 months, respectively, whereas those statistics are 74 and 58 months, respectively for third-party acquisitions. These differences suggest that the reacquisitions tend to occur sooner than the third-party acquisitions. The average and median acquisition premium, based on the price of the ECO on the 42nd trading day prior to the merger announcement date, are 46% and 37%, respectively. However, when we compute the premium using the price of the target on the sixth trading day prior to the announcement those statistics are 34% and 25%, respectively; this lower level of premium suggests a possible information leakage prior to the merger (Schwert, 1996). The median post-IPO parent ownership in acquired carve-outs is 72%. As shown in Panel B of Table 3, around 77% of acquired carveouts have majority parent ownership. We also observe that around 56% of the acquired carve-outs have parent ownership above 50% prior to their acquisition. In our sample of acquired carve-outs, 31% have the parent and carve-out in the same industry and 16% have dual-class shares. Finally, 58% of carve-out mergers in our sample are financed through only cash, and in around 11% of mergers a lawsuit is filed either by a competing bidder or by the minority shareholders. 4. Results 4.1. Likelihood of acquisition: Probability of acquisition In Table 4, we report the results of the logit analysis in which the dependent variable Acquired takes on a value of one if the carve-out is acquired and zero if the carve-out is traded in the market (‘survived’), within 5 years of its IPO offer date.18 For this analysis, following Field and Karpoff (2002), we ignore the carve-outs which are delisted or have gone bankrupt (‘failed’) within 5 years of their IPOs (24 observations). Since we are restricting this sample to carve-outs that are acquired within 5 years of IPOs, our overall sample is of 198 carve-outs, of which 77 are acquired. Our primary specification (Model 1) is:

Acquiredi ¼

eyi 1 þ eyi

ð1Þ

where yi ¼ A0 þ A1  Unlocking i þ A2  DParent Owni þ A3  ðHi-TechÞi

17 In empirical analyses, we conservatively assign values of zero for these missing data; results remain the same without such adjustment. 18 Because our cut-off date is 12/31/2007, we could not follow one carve-out (IPO offer date 11/20/2003) for the full five years.

C.A. Desai et al. / Journal of Banking & Finance 35 (2011) 3432–3449

As reported in Model 1, the coefficient of 1.089 on the dummy variable Unlocking indicates that when the reason for undertaking a carve-out is to unlock the value, the odds of that carve-out to get acquired increase by a factor of 2.97 over the instance when the reason is other than to unlock the value. In terms of the probability, if the reason for undertaking a carve-out is to unlock the value, then the probability of acquisition for that carve-out changes from 0.5 to 0.75; this change is significant at the 5% level (z-value: 2.28).19,20 The coefficient of 1.583 on DParent Own suggests that an additional one-percentage decline in the post-IPO parent ownership in a carve-out causes a reduction of 0.791% in the probability of acquisition of this carve-out.21 The coefficient of 0.676 on Hi-Tech shows that if the carve-out operates in the hi-tech industry, then there is approximately a 66% (34%) chance that this carve-out will be acquired (survived). This result supports findings of Kohers and Kohers (2000) who conjecture that the likelihood of acquisition will be higher in the hi-tech industry due to above-average returns in that industry. In Models 2–5, we change our primary specification to incorporate other factors of interest and controlling variables. As mentioned in Section 2.2, the parent is likely to retain majority ownership in the carved-out subsidiary if it has business relations with the subsidiary. In that case, the effect of post-IPO parent ownership may confound the effect of ongoing business connections on the carve-out’s acquisition. Therefore, to separate these two effects, we exclude DParent Own and include variables related to the business relationships in Model 2. The coefficient of 0.615 on dummy variable Product Market indicates that the odds of acquisition increase by a factor of 1.85 when the parent and subsidiary are connected through a product-market relationship, and this change is significant at the 10% level (z-value: 1.79). In Models 4 and 5, we use a dummy variable Parent Own P 50% instead of a continuous variable DParent Own. As shown in Model 4, the coefficient of 0.869 on Parent Own P 50% suggests that the odds of ECO acquisition increase by a factor of 2.38 when the parent retains majority ownership in the post-IPO carve-out, and this difference is significant at the 10% level. In Models 2 and 5, we include variables Financial and Same Industry. For brevity, we do not show their coefficients, due to their statistical insignificance. As shown in Model 4, the coefficient of 0.915 on Dual Class indicates that the odds of acquisition increase by a factor of 2.50 when the carve-out has dual class shares compared to the case when it has shares with only one class. This change is significant at the 10% level. In addition, in unreported regressions, when we add the variable Dual Class in our Models 1–3, we find its insignificant impact on the likelihood of acquisition in Models 1 and 3, and in Model 2, its impact is significant at the 10% level. This counterintuitive finding to our hypothesis H3, at first, suggests that the anti-takeover provisions actually increase the likelihood of acquisition in the case of carve-outs. One plausible explanation for this finding is: in examining the SEC filings, we find that in the case of ECOs with dual class shares, the parent firm generally retains full ownership of the superior voting shares

19 More precisely, the increase in odds is equal to e1.089 = 2.97. Assuming that if there are reasons other than to unlock the value, then the probability of acquisition p1 = 0.5, and the odds = 1. When the reason is to unlock the value, the new odds = 2.97, which will make new p1 = 0.748. 20 In all our multivariate analyses, t and z values are based on heteroskedasticityrobust standard errors clustered at the parent firm level. 21 More precisely, assuming that before the IPO, the parent owns 100% of the subsidiary. In the first case, the parent retains 81% (i.e. it sells 19% of its ownership in IPO) of the subsidiary, and in the second case, the parent retains 80%. Thus, DParent Own in the first (second) case is 19% (20%), and the change in DParent Own is equal to 0.01, and the new odds = e1.5830.01 = 0.9843. Therefore, the new probability of acquisition is 0.4960, which was previously 0.5.

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while it retains minimal or no ownership of the inferior voting shares. In this manner, the parent voting ownership increases significantly whereas its cash flow ownership is negligible. We define the ownership based on the voting rights. Therefore, this effect of dual class shares is possibly the effect of parent ownership in the post-IPO carve-out.22 If we examine the effect of another form of anti-takeover provision (Staggered) in Models 3–5, it is negative albeit statistically insignificant. Therefore, we do find some support of our hypothesis H3. In an unreported analysis, we also test the difference between the estimated coefficients of various categories of parent motives. For example, in Model 2, the test of difference of estimated coefficients for Unlocking and Financing has a v2 value of 6.02 with a pvalue of 0.01. Similarly, the estimated coefficient for Unlocking is significantly higher than that of the Restructuring, with a v2 value of 6.74; whereas there is no significant difference in the estimated coefficients of Financing and Restructuring (v2 = 1.82). These results suggest that the probability of acquisition significantly increases when the parent’s motive is to unlock the value of the subsidiary compared to that when the motive is either to finance or to restructure the operations. Overall, the results reported in Table 4 indicate that the probability of ECO acquisition increases when the parent’s motive for conducting a carve-out is to unlock the value, with the increase in parent ownership in the post-IPO carve-out, and when the parent and subsidiary are connected through a product-market agreement. These findings support our hypotheses H1 and H2. 4.2. Robustness check Our results of the logit analysis on the ECO acquisition can potentially produce biased results if we ignore the fact that at the time of making the subsidiary a public company, the parent could choose whether to conduct a carve-out or to conduct a spinoff. In addition, if the parent decides to conduct a carve-out, then it can determine the level of ownership it needs to retain in the carved-out subsidiary. If we ignore the former, i.e., the choice between a carve-out and a spinoff, our results are likely to be biased due to self-selection. And if we ignore the latter, i.e., the possibility that the parent ownership in the post-IPO carve-out is endogenously determined, our results may be incorrect due to endogeneity. To check our results for sample selection bias we merge our carve-out sample with a sample of spinoffs and perform a two-step Heckman procedure. To check our results for endogeneity bias, we repeat our analysis using exogenous instrumental variables. Our results remain the same under both sets of analyses and there is no indication that our findings are affected by selection or endogeneity bias. Details of these tests are in Desai et al. (2011). 4.3. Likelihood of acquisition: Time-to-acquisition After an IPO, a carve-out can be actively traded, failed, or acquired in the market. The right-censored observations in our dataset are those ECOs that are either actively traded or failed as of the cut-off date, December 31, 2007. The usefulness of estimating the parameters using the survival (failure)/time-to-event analysis over the logit or probit analysis is its ability to incorporate information of right-censored observations and the time till the carve-out survives in the market before its acquisition.23 We use a dichotomous variable describing the status of a carve-out as either acquired or 22 For example, in our sample of 39 ECOs with dual class shares, the average parent ownership is 82.6% and for 183 ECOs without dual class shares, that statistic is 57.7%; the difference is significant at the 1% level. 23 For an application of survival analysis, see Cleves et al. (2004).

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not-acquired (both failed and survived). When interpreting the results of the survival analysis, we refer to the probability of failure for a carve-out as the probability of its being acquired. We use non-parametric and semi-parametric approaches of survival analysis to assess the impact of our selected variables on the failure and hazard functions.24 The non-parametric technique helps us analyze the differences in failure functions of groups based on a dummy variable. The semi-parametric approach allows us to model the impact of more than one explanatory variable on the hazard rate of acquisition. Both approaches make no assumptions regarding the distribution of time-to-acquisition. 4.3.1. Non-parametric analysis The non-parametric analysis involves plotting Kaplan–Meier (K–M) failure function estimates for groups based on the parent’s motive for conducting a carve-out, post-IPO parent ownership, business relationship of parent and subsidiary, and industry structure of a carve-out; and then conducting statistical tests to determine whether the differences in the failure functions are significant. We find that the probability of acquisition at any given time is higher when the parent’s motive for conducting a carve-out is to unlock the value of the subsidiary than when the parent does not report this motive, and this difference is statistically significant at the 1% level. We also find that the probability of acquisition at any given time is higher for the carve-outs with post-IPO parent ownership above fifty percent than that for the carve-outs with post-IPO ownership below fifty percent, and this difference is also statistically significant at the 1% level. Furthermore, the probability of acquisition is consistently higher for ECOs with a product-market relationship with the parent than for ECOs without such product-market relationship with the parent, and this difference is statistically significant at the 5% level. We find that firms operating in a hi-tech industry have a higher estimated probability of acquisition. However, this last result is not statistically significant, though it is close with a p-value of 10.3%. Finally, we also observe that the probability of acquisition is lower when the parent’s motive is to restructure the operations than that when the parent’s motive is other than to restructure the operations; the difference of these two failure functions is significant at the 5% level. The actual failure function plots and statistical test values are in Desai et al. (2011). 4.3.2. Semi-parametric analysis We perform a semi-parametric technique using the Cox Proportional Hazard model. This assumes that the baseline hazard, or the inherent risk of acquisition in the absence of all control variables, is the same for each ECO. In Model 1 of Table 5, we use variables which have a significant effect on the K-M failure function estimates as discussed in Section 4.3.1. Mathematically, it is

hi ðtÞ ¼ h0 ðtÞ  exp½A1  ðUnlocking i Þ þ A2  ðRestructuring i Þ þ A3  ðParent Own P 50%i Þ þ A4  ðProduct Marketi Þ ð2Þ where hi(t) is the hazard of acquisition for a given carve-out i at time t and h0(t) is the baseline hazard function. We define the log 24 If t = 0 is the IPO date and t = T is the acquisition date which is a random variable, then the survival function S(t) of a carve-out is defined as the probability of its surviving until time t. Mathematically, S(t) = P(T P t). The failure function is a complement of a survival function. It is the cumulative probability of failure (in our case, acquisition of a carve-out) at any given time t. Mathematically, F(t) = 1  P(T P t). The hazard function h(t)—also known as the hazard, hazard rate—is the probability of a carve-out to get acquired at this infinitesimal time-interval conditional on its surviving until the beginning of the interval, divided by the duration of this time-interval.

of the relative hazard (LRH) as the natural logarithm of the ratio of hi(t) to h0(t). That is,

LRH ¼ A1  ðUnlocking i Þ þ A2  ðRestructuring I Þ þ A3  ðParent Own P 50%i Þ þ A4  ðProduct Marketi Þ ð3Þ The results of Model 1 indicate that the hazard (risk) of acquisition increases when (a) the parent’s motive is to unlock the value; (b) the post-IPO parent ownership is above 50%; and (c) the parent and the carve-out are tied through a product-market business agreement. The hazard of acquisition decreases when the parent’s reason for conducting a carve-out is to restructure its own and the subsidiary’s operations. First, the coefficient of 0.708 on Unlocking indicates that the estimated hazard ratio of the groups based on the dummy Unlocking is 2.03.25 Therefore, the hazard of acquisition for the carve-outs which are undertaken by the parent with a motive of unlocking the value is 2.03 times higher than that of carve-outs where the parent undertakes the carve-out transaction for reasons other than to unlock the value, and the difference between these two hazard rates is significant at the 1% level (t-value: 3.11). This result supports the validity of our hypothesis H1. Second, the coefficient of 0.441 on Parent Own P 50% shows that the risk of acquisition for a carve-out with a majority ownership by the parent is 1.55 times higher than that for a carve-out with less than majority ownership by the parent. This difference in hazard rates is significant at the 10% level (t-value: 1.95). We also find that the hazard of acquisition for a carve-out having a product-market relationship with the parent firm is higher than that for a carve-out without such a relation, albeit the difference is significant at the 10% level. These findings support our hypothesis H2. Finally, the coefficient of 0.675 on the dummy Restructuring indicates that the risk of acquisition for a carve-out in which the parent’s motive is to restructure the operations is 0.51 times that of the carve-outs in which the parent’s motive is other than the restructuring. It is likely that when the parent with a restructuring motive consummates the equity carve-out transaction, their main purpose is to achieve the benefits of divestitures (Hulburt et al., 2002; Vijh, 2002) and not to prepare the carveout for acquisition. In Model 2, we exclude variables related to the parent ownership and include variables measuring the ongoing financial relationship between the parent and the carved-out subsidiary, industry relatedness, and size related controls in our Model 1. In Model 3, we modify Model 1 by using a continuous variable reflecting the change in parent ownership before and after the IPO of the carve-out (DParent Own). The coefficient of -0.853 suggests that when the parent sells an additional percentage point of shares of subsidiaries in the IPO (i.e., the parent reduces its ownership in the subsidiary by an additional percentage point), the hazard of the carve-out acquisition decreases by 0.85%.26 This finding supports our hypothesis H2. In Models 4–8, we add our proxies for the anti-takeover provisions, the industry structure of the carve-outs, and other controlling factors. As shown in Model 7, at first look it seems that the post-IPO blockholder ownership increases the hazard of acquisition. However, when we exclude the parent ownership, the blockholder ownership loses its significance. For this reason, we 25

More precisely, it is e0.708 = 2.0299. More precisely, refer to footnote 21, let the change in DParent Own is equal to @ðLRHÞ 0.01. Based on our Model 3, @ðDParent OwnÞ ¼ 0:853. Since the baseline hazard h0(t) remains constant, after some minor algebra we find that hh21 ðtÞ ¼ expð0:01 ðtÞ 0:853Þ ¼ 0:9915, where h2(t) and h1(t) are the hazard rates for the second and the first cases, respectively. 26

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C.A. Desai et al. / Journal of Banking & Finance 35 (2011) 3432–3449 Table 3 Summary statistics for the sample of acquired (N = 137) equity carve-outs. Panel A: Descriptive statistics Variable

Mean

Median

Std. Dev

Min

Max

Dependent Variables Acquisition Time (in months) – Total sample Parent re-acquisition (N = 48) Third-party acquisition (N = 89) Acquisition Premium_42 (%) Acquisition Premium_Returns Acquisition Premium_06 (%)

69 59 74 45.8 17.7 33.7

54 48 58 36.9 13.2 25.3

47 37 50 51.0 22.3 36.8

8 14 8 70.6 33.0 70.6

217 172 217 240.9 76.9 194.7

Post-IPO Parental Influence Parent Ownership Before (%) Parent Ownership (%) Parent Directors (%)

94.5 65.5 44.0

100.0 72.0 42.9

12.2 25.4 19.9

50.0 0.0 0.0

100.0 98.4 100.0

Other Control Variables Blockholder Ownership (%) Insider Ownership (%) CEO Ownership (%) Inside Directors (%) Outside Directors (%) Board Size Offer Size (in millions $) Size Ratio Performance (%)

6.8 2.8 1.5 10.5 45.6 7.18 129.95 0.54 2.0

0.0 1.0 0.0 11.1 42.9 7.00 45.00 0.24 14.7

12.1 4.8 8.3 11.4 17.9 2.27 314.96 0.83 77.8

0.0 0.0 0.0 0.0 0.0 3.00 2.50 0.00 114.5

57.2 28.7 95.0 50.0 83.3 20.00 2800.00 7.39 656.2

Merger Related Pre-Acq ECO Size (in millions $) ECO-Bidder Size Ratio

699.72 0.49

170.51 0.19

1636.54 0.65

2.05 0.00

12677.49 3.59

Panel B: Statistics of dummy variables Variable

% of sample

N

49 20 11

35.8 14.6 8.0

137 137 137

Post-IPO Parental Influence Parent Own P 50% Parent Own P 80% Parent on Audit Parent CEO Parent Chair Product Market Financial Same Industry

105 52 35 75 107 89 79 43

76.6 38.0 28.5 54.7 78.1 65.4 58.1 31.4

137 137 123 137 137 136 136 137

Anti-Takeover Provision Staggered Dual Class Delaware

52 22 112

38.0 16.1 81.8

137 137 137

Industry Structure Hi-Tech

49

35.8

137

Other Control Variables Blockholder Own P 5% Insider Own P 1% CEO Own P 1% Large Board CEO Duality

52 69 33 78 53

38.0 50.4 24.1 56.9 38.7

137 137 137 137 137

Merger Related Pre-Acq Parent Own P 50% Cash Merger Lawsuit Multiple Bidder Pre-Acq Insider Own P 1% Pre-Acq Blockholder Own P 5%

76 80 15 20 73 68

55.5 58.4 10.9 14.6 53.3 49.6

137 137 137 137 137 137

Parent’s Motive Financing Unlocking Restructuring

Dummy = 1

Notes: The number of observations (N) for all variables of panel A is 137, except for the ECO-Bidder Size Ratio, for which we have data for 94 firms due to non-availability of size data for non-public bidders. N stands for number of acquired carve-outs. Appendix A describes the variables in detail.

show it for only one of our specifications. As shown in Models 6 and 8, the carve-outs with a higher percentage of inside directors tend to survive longer. Intuitively, inside directors are those who never worked for the parent firms before. While going over the proxy statements of these firms, we observe that these inside

directors are the entrepreneurs who have worked in the carveout firm from its inception. At some point in the life of the carveout, the parent firm took over the carve-out and made it a wholly-owned subsidiary. If the carve-out board is dominated with such founding executives as directors, it is likely that the carve-out

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Model 2

Model 3

Model 4

Model 5

0.095 [0.27]

0.159 [0.44]

0.184 [0.47]

0.215 [0.55]

1.337b [2.47]

1.243b [2.31]

1.350b [2.42]

1.396b [2.49]

0.940 [1.58]

0.502 [0.77]

0.543 [0.86]

0.530 [0.86]

0.869c [1.68]

0.906c [1.70]

For all our specifications, we perform a global test to check the proportionality assumption as suggested in Cleves et al. (2004). An unreported v2 statistic suggests that in all our models we fail to reject the null hypothesis that the log of the proportional hazard is constant over time, suggesting that our models are well-specified. Overall, the results of the Cox proportional hazard analysis suggest that the time-to-acquisition has a positive relation with the parent motive to unlock the value, majority ownership by the parent in the post-IPO carve-out, and the ongoing product-market association between the parent and the ECO. These results support our hypotheses H1 and H2. Also, the time-to-acquisition has an inverse relationship with the parent motive to restructure the operations.

0.061 [0.05]

4.4. Analysis on parent-reacquisition versus third-party acquisition

Table 4 Logit analysis of ECO acquisition in the first 5 years of IPO. Model 1 Financing Unlocking

1.089b [2.28]

Restructuring

DParent Own

1.583b [2.33]

1.611b [2.06]

Parent Own P 50% Parent Directors

0.748 [0.66]

Parent on Audit

0.090 [0.23]

0.076 [0.19]

Parent CEO

0.638c [1.75]

0.711 [1.38]

0.627c [1.71]

0.752b [2.08]

0.735c [1.95]

0.430 [1.21]

0.451 [1.24]

0.491 [1.37]

0.915c [1.71]

0.989c [1.82]

0.602 [1.55]

0.580 [1.47]

Blockholder Own P 5%

0.506 [1.18]

0.496 [1.16]

Insider Own P 1%

0.341 [0.83]

0.359 [0.86]

0.615c [1.79]

Product Market Staggered Dual Class Hi-Tech

0.676c [1.87]

0.559 [1.46]

0.528 [1.40]

Inside Directors

1.534 [1.02]

0.427 [0.21]

Log (Board Size)

0.410 [0.64]

0.521 [0.82]

Log (Offer Size)

0.007 [0.05]

0.062 [0.46]

0.020 [0.14]

0.049 [0.33]

Log (Size Ratio)

0.112 [0.91]

0.119 [0.95]

0.175 [1.25]

0.172 [1.23]

Constant

0.306 [1.03]

0.936 [0.42]

0.376 [0.14]

1.858 [0.73]

1.290 [0.46]

LR test statistic Pseudo R2

13.80a 0.07

16.83c 0.08

23.27b 0.10

23.30c 0.13

25.56 0.13

Notes: Dependent variable takes on a value of one (zero) if an ECO is acquired (survived). The sample is of 198 ECOs, of which 77 are acquired. The z-values are based on heteroskedasticity-robust standard errors clustered at the parent firm level and are in brackets below the coefficients. Models 2 and 5 also include Financial and Same Industry; their coefficients are insignificant. Appendix A describes the independent variables in detail. LR stands for Likelihood Ratio. a Significance at the 1% level. b Significance at the 5% level. c Significance at the 10% level.

will survive longer in the market since the inside directors’ prime objective is likely to grow the carve-out and not to prepare it for an acquisition. Finally, although we do not find any statistically significant impact of our chosen anti-takeover provisions on the hazard of ECO acquisition, the signs of their coefficients are worth mentioning. As shown in Models 5 and 8, the coefficient of Dual Class is positive, which suggests that the presence of this anti-takeover provision in a carve-out increases the hazard of its acquisition. As explained earlier, this positive sign may be due to the significant voting ownership of the parent firm in a carve-out with dual class shares. The coefficient of Staggered is negative but statistically insignificant, which to some extent supports our hypothesis H3.

4.4.1. Multinomial analysis on post-IPO carve-out status To assess whether our chosen factors have a different impact on the probability of re-acquisition, third-party acquisition, or failure of a carve-out compared to the survived one, we perform the multinomial logit analysis and report the findings in Table 6. The base category for this analysis is those carve-outs which survived within 5 years of their IPOs. For brevity, we report results of only three specifications: Models 1, 2, and 3 of Table 6 are the same as Models 1, 2, and 5 of Table 4, respectively. Models 2 and 3 of Table 6 include variables Log (Offer Size) and Log (Size Ratio), and Model 3 includes Parent Directors, Parent on Audit, Parent CEO, Blockholder Own P 5%, Insider Own P 1%, Inside Directors, and Log (Board Size). We do not report their coefficients due to their statistical insignificance. As shown in Model 1, compared to the likelihood of an ECO’s survival in the market, the likelihood of its re-acquisition increases when the parent’s motive is to unlock the value of the subsidiary and when the parent sells fewer shares of the ECO during the IPO. The coefficients of 1.420 on Unlocking suggests that when the reason for undertaking a carve-out is to unlock the value of the subsidiary, the odds of that carve-out to get re-acquired versus to be alive in the market (base category) increase by 4.14; this increase is significant at the 5% level (z-value: 2.50). We also find some evidence that the parent’s motive to unlock subsidiary value increases the probability of third-party acquisitions versus the base category as shown in Models 2 and 3. These findings support our conjecture based on the insight of Perotti and Rossetto (2007). An equity carve-out helps the parent ascertain its synergy with the subsidiary. Depending on positive or negative value of the synergy, the parent takes the decision to re-acquire or to sell-off the remaining portion to a third-party. Therefore, the probability of re-acquisition as well as that of third-party acquisition increases when the parent’s motive is to unlock the value of the subsidiary. Regarding the impact of post-IPO parental control on the status of the carve-out, we find evidence that post-IPO parent ownership and ongoing business connection between the parent and the subsidiary have a positive impact on the probability of re-acquisition. As shown in Model 3, the statistical significance of the coefficient on Parent Own P 50% indicates that the probability of the parent re-acquiring the ECO versus the ECO surviving independently in the market significantly increases when the parent retains majority ownership in the post-IPO carve-out; the coefficient on Parent Own P 50% is insignificant when we compare the third-party acquisition versus the base (survived) category or the failed ECO category versus the base category. This result supports the findings of Klein et al. (1991).27 Finally, as shown in Model 2, the coefficient 27 In their sample of 52 equity carve-outs, Klein et al. (1991) find that 25 firms have the parent retained ownership above 80%. Of these 25 carve-outs, 17 were subsequently re-acquired by the parent firm.

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C.A. Desai et al. / Journal of Banking & Finance 35 (2011) 3432–3449 Table 5 Cox proportional hazard estimation. Model 1 Financing

Model 2

Model 3

Model 4

Model 5

Model 6

Model 7

Model 8

0.198 [0.99]

0.201 [1.01]

0.268 [1.32]

0.261 [1.29]

0.268 [1.32]

0.303 [1.47]

0.307 [1.49]

Unlocking

0.708a [3.11]

0.624b [2.34]

0.624b [2.47]

0.633a [2.61]

0.650a [2.68]

0.660a [2.73]

0.723a [2.94]

0.631b [2.51]

Restructuring

0.675c [1.96]

0.728b [2.00]

0.619 [1.63]

0.673c [1.79]

0.648c [1.73]

0.676c [1.85]

0.707b [2.02]

0.537 [1.45]

Parent Own P 50%

0.441c [1.95]

0.464b [2.03]

0.409c [1.78]

0.507c [1.95]

0.756a [2.81]

0.449 [1.64]

0.853b [2.01]

DParent Own Parent Directors

0.689 [1.06]

Parent on Audit

0.270 [1.38]

Parent CEO Product Market

0.260 [0.37]

0.218 [0.80] 0.342c [1.89]

0.395b [2.17]

Financial

0.231 [1.23]

Same Industry

0.033 [0.16]

0.321c [1.78]

0.288 [1.47]

0.364b [2.01]

0.348c [1.86]

0.249 [1.26] 0.284 [0.99]

0.348c [1.90]

0.277 [1.30] 0.203 [1.06]

0.035 [0.17]

0.070 [0.34]

Staggered

0.152 [0.82]

0.172 [0.90]

Dual Class

0.149 [0.53]

0.170 [0.59]

Hi-Tech

0.228 [1.05]

0.219 [0.97]

Blockholder Own P 5%

0.477b [2.12]

Insider Own P 1%

0.239 [1.14]

0.341c [1.65]

Inside Directors

1.897c [1.76]

1.924c [1.68]

Log (Board Size)

0.223 [0.57]

0.391 [1.00]

Log (Offer Size)

0.007 [0.09]

0.013 [0.17]

0.058 [0.73]

0.024 [0.31]

0.004 [0.05]

0.035 [0.44]

0.073 [0.84]

Log (Size Ratio)

0.075 [1.09]

0.065 [0.96]

0.082 [1.12]

0.069 [0.97]

0.042 [0.59]

0.048 [0.70]

0.092 [1.21]

Notes: Total sample is of 222 ECOs, of which 137 are acquired. Appendix A contains the description of variables. The t-values are in brackets below the coefficients and are based on heteroskedasticity-robust standard errors clustered at the parent firm level. a Significance at the 1% level. b Significance at the 5% level. c Significance at the 10% level.

of 1.368 on the dummy variable Product Market suggests that the odds of a parent re-acquiring the carved-out subsidiary over the carve-out maintaining status as an independent identity in the market increase by 3.93, when the parent and the carved-out subsidiary have an ongoing product-market relationship and this increase is statistically significant at the 5% level. Overall, our results of the multinomial logit analysis show that the probability of re-acquisition over the ECO remaining alive in the market increases when the parent’s motive is to unlock the value, when the parent retains majority ownership in the post-IPO carve-out, and when the parent and carved-out subsidiary have an ongoing product-market relationship. 4.4.2. Time-to-acquisition for re-acquisition and third-party acquisition We also perform the hazard analysis on the subsamples of reacquisitions and third-party acquisitions and report the results in

Table 7. The specifications for this analysis are the same as those for Models 1–4 of Table 5. As shown in Table 7, the hazard of re-acquisition and thirdparty acquisition increase when the parent’s motive is to unlock the value of the subsidiary. These findings further support our conjecture based on Perotti and Rossetto’s (2007) model. When the parent undertakes a carve-out to unlock the value of a subsidiary, the acquisition of the subsidiary is imminent, either by the parent or by a third-party. We also find statistically significant positive impacts of parent ownership and its product-market relationship with the subsidiary on the hazard of a carve-out in the case of re-acquisitions. We, however, do not find a statistically significant impact of these two variables in the case of third-party acquisitions. The differences in coefficients’ signs on Financing for re-acquisitions and for third-party acquisitions are noteworthy. We find that when the parent consummates a carve-out transaction for

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C.A. Desai et al. / Journal of Banking & Finance 35 (2011) 3432–3449

Table 6 Multinomial logit analysis for post-IPO carve-out status. Model 1 Re-acquired versus Survived

Model 2 Third-party versus Survived

Failed versus Survived

Financing Unlocking

1.420b [2.50]

0.801 [1.39]

0.089 [0.11]

Restructuring

DParent Own

4.488a [3.42]

0.509 [0.75]

Model 3

Re-acquired versus Survived

Third-party versus Survived

Failed versus Survived

Re-acquired versus Survived

Third-party versus Survived

Failed versus Survived

0.499 [0.93]

0.107 [0.27]

0.012 [0.03]

0.602 [1.16]

0.109 [0.26]

0.101 [0.18]

1.641b [2.39]

1.102c [1.79]

0.566 [0.62]

1.686b [2.47]

1.192c [1.72]

0.869 [0.82]

1.712 [1.55]

0.604 [0.92]

0.589 [0.61]

1.000 [0.87]

0.326 [0.49]

0.021 [0.02]

1.921b [2.11]

0.444 [0.83]

0.170 [0.21]

1.952c [1.88]

Parent Own P 50% Product Market

1.368b [2.56]

0.344 [0.81]

0.121 [0.27]

1.423b [2.45]

0.488 [1.10]

0.022 [0.04]

Financial

0.537 [0.98]

0.464 [1.25]

0.407 [0.83]

0.393 [0.71]

0.385 [0.95]

0.315 [0.63]

Staggered

0.592 [1.12]

0.445 [1.06]

0.847c [1.75]

Dual Class

1.147 [1.51]

0.885 [1.46]

1.530b [2.14]

Hi-Tech

0.900 [1.48]

0.571 [1.55]

0.140 [0.27]

Same Industry Constant

0.765c [1.94]

LR test statistic Pseudo R2

24.11a 0.07

1.066a [3.01]

0.978a [2.62]

0.664 [1.27]

0.488 [1.14]

0.389 [0.69]

0.695 [1.33]

0.440 [1.00]

0.152 [0.25]

0.485 [0.86]

0.616 [1.44]

0.961b [2.10]

0.301 [0.55]

0.529 [1.19]

1.030b [2.01]

4.430 [1.41]

0.778 [0.29]

2.125 [0.65]

6.831 [1.59]

1.746 [0.54]

0.992 [0.21]

51.48a 0.10

78.64b 0.16

Notes: This table reports the results of a multinomial logit analysis for the post-IPO carve-out status in 5 years from the IPO. Specifications are same as those of Models 1, 2 and 5 of Table 4. The base category is the ECOs survived in the market, whereas the other categories are re-acquired, third-party acquired, and failed ECOs. The detailed list of explanatory variables is in Appendix A. For brevity, we do not show coefficients of variables Log (Offer Size), Log (Size Ratio), Parent Directors, Parent on Audit, Parent CEO, Blockholder Own P 5%, Insider Own P 1%, Inside Directors, and Log (Board Size); their impacts are insignificant. The number of carve-outs in Survived, Re-acquired, Third-party, and Failed category is 121, 32, 45, and 24, respectively. The z-values are in brackets below the coefficients and are based on heteroskedasticity-robust standard errors clustered at the parent firm level. a Significance at the 1% level. b Significance at the 5% level. c Significance at the 10% level.

financing related purposes, the hazard of re-acquisition is lower than that when the parent undertakes a carve-out for purposes other than financing and this difference is statistically significant; however, the hazard of a third-party acquisition is actually higher, albeit the difference is statistically insignificant. A possible explanation for this is that when the parent undertakes a carve-out to finance the operations, it views the subsidiary mainly for a means of financing rather than for the synergistic gains. Therefore, the parent is less likely to be interested in reacquiring the subsidiary and more likely to be interested in selling the remaining portion of the ECO to a third-party in the future. Overall, to a large extent, the results of the hazard analysis on the subsamples of re-acquisitions and third-party acquisitions support our earlier results of multinomial analysis on the post-IPO carve-out status.

4.5. Acquisition premium As shown earlier in Table 3, the mean and median time-toacquisition of acquired carve-outs is approximately 5 years from their IPO dates. If our objective is to determine ex-post the impact of our chosen variables at the time of the IPO on the level of the acquisition premium, then we need to consider the carve-outs that

are acquired closer to their IPO dates. Therefore, for the purpose of analysis in this subsection, we focus only on those carve-outs that are acquired within 5 years of their IPO dates. In addition, for brevity, we report results using Acquisition Premium_42 as a measure of the level of premium.28 4.5.1. Univariate analysis In Table 8, we report the results of a univariate analysis comparing the mean and median acquisition premium for the groups based on selected dummy variables for the sample of carve-outs acquired within 5 years of an IPO (N = 77).29 The mean and median acquisition premium for the carve-outs with dual class voting shares (N = 16) are 13.6% and 7% respectively, whereas the same statistics are 55.3% and 49.1% for carve-outs with one class of voting shares (N = 61). The differences are statistically significant at the 1% level with t and z values of 2.65 and 3.18, respectively. These results, at a first glance, suggest that the anti-takeover provisions in a carve-out seem to reduce its acquisition premium. 28 We find qualitatively similar results when we use Acquisition Premium_Returns and Acquisition Premium_06. 29 The results of univariate analysis for the total sample of acquired carve-outs (N = 137) are similar to those reported here for the sample of acquired carve-outs within 5 years of IPO; they are available in Desai et al. (2011).

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C.A. Desai et al. / Journal of Banking & Finance 35 (2011) 3432–3449 Table 7 Hazard analysis for parent re-acquisitions and third-party acquisitions. Re-acquisitions Model 1 Financing

Third-party acquisitions Model 2

Model 3

Model 4

0.848b [2.16]

0.741c [1.89]

1.034b [2.53]

Model 5

Model 6

Model 7

Model 8

0.107 [0.45]

0.107 [0.44]

0.090 [0.37]

Unlocking

0.999b [2.44]

0.588 [1.26]

0.794c [1.89]

0.751c [1.80]

0.537c [1.90]

0.591c [1.80]

0.576c [1.74]

0.562c [1.75]

Restructuring

1.786c [1.77]

1.978c [1.79]

1.534 [1.47]

1.827c [1.68]

0.449 [1.25]

0.421 [1.13]

0.396 [1.03]

0.375 [0.99]

Parent Own P 50%

1.507a [2.72]

1.630a [2.86]

0.098 [0.38]

3.104a [3.53]

DParent Own Product Market

0.074 [0.29]

0.829b [2.35]

0.846a [2.61]

Financial

0.635c [1.80]

Same Industry

0.560 [1.59]

0.762b [2.22]

0.011 [0.02] 0.684b [2.04]

0.115 [0.52]

0.181 [0.78]

0.155 [0.66]

0.103 [0.39]

0.004 [0.02] 0.402 [1.15]

Hi-Tech

0.342 [1.32]

0.346 [1.32]

0.220 [0.65]

0.239 [0.85]

Log (Offer Size)

0.109 [0.71]

0.051 [0.33]

0.201 [1.47]

0.043 [0.44]

0.029 [0.29]

0.008 [0.08]

Log (Size Ratio)

0.085 [0.59]

0.106 [0.72]

0.074 [0.49]

0.063 [0.78]

0.053 [0.64]

0.084 [0.95]

222 48

222 48

222 48

222 89

222 89

222 89

Observations Acquisitions

222 48

222 89

Notes: This table reports the results of the hazard analysis on the subsamples of parent re-acquired and third-party acquired carve-outs. The specifications used for this analysis are the same as those used in Models 1–4 of Table 5. A detailed description of variables is given in Appendix A. The t-values are in brackets below the coefficients and are based on heteroskedasticity-robust standard errors clustered at the parent firm level. a Significance at the 1% level. b Significance at the 5% level. c Significance at the 10% level.

Table 8 Differences in acquisition premiums on selected indicator variables. Variable

Variable = 0

Variable = 1

Differences

N

Mean

Median

N

Mean

Median

t

z

Unlocking Parent Own P 80% Parent on Audit Dual Class Insider Own P 1% CEO Own P 1% Large Board Lawsuit Reacquisition Cash Merger Pre-Acq Parent Own P 50%

63 47 58 61 34 55 33 67 45 29 27

0.434 0.516 0.427 0.553 0.338 0.403 0.632 0.456 0.584 0.357 0.686

0.313 0.452 0.421 0.491 0.232 0.282 0.452 0.369 0.441 0.250 0.441

14 30 19 16 43 22 44 10 32 48 48

0.608 0.388 0.585 0.136 0.567 0.622 0.341 0.536 0.300 0.532 0.340

0.536 0.194 0.250 0.070 0.491 0.492 0.278 0.521 0.266 0.511 0.294

1.01 0.95 1.03 2.65a 1.74c 1.30 2.11b 0.66 2.36b 1.19 2.36b

1.46 1.50 0.34 3.18a 1.74c 1.35 1.79c 1.05 1.94c 2.45b 2.06b

Notes: This table presents the differences in acquisition premium for the groups formed on various dummy variables. For this analysis, we restrict the sample to only those carve-outs which are acquired within 5 years of their IPO dates (N = 77). We compute acquisition premium using the ECO price on 42nd trading day price as the base. Dummy equal to one indicates presence of the particular variable. N is the number of observations. A description of variables is given in Appendix A. The t and z statistics are for the test comparing mean and median, respectively. a Significance at the 1% level. b Significance at the 5% level. c Significance at the 10% level.

However, as mentioned earlier, the effect of dual class shares might be actually the effect of parent ownership since the parent can use dual class of shares to retain a large percentage of voting rights in a carve-out. We find that the parent ownership in a carve-out prior to the merger is likely to impact the level of acquisition premium. For example, the mean and median acquisition premium for the group

of carve-outs in which the parent ownership prior to the acquisition is above 50% (N = 48) are 34% and 29.4%, respectively. The same statistics for the other group of carve-outs with parent ownership below 50% prior to the merger (N = 27) are 68.6% and 44.1%, respectively. The differences of mean and median acquisition premium for these two groups are statistically significant at the 5% level. The mean and median acquisition premium for the group

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Table 9 Impact of equity carve-out characteristics on acquisition premium. ECOs acquired within 5 years of IPO Model 1

Model 2

Model 3

Model 4

Model 5

Model 6

0.679a [5.12]

0.572a [3.01]

1.513c [1.76]

0.415 [0.47]

2.163b [2.04]

1.922c [1.87]

0.193 [1.24]

0.201 [1.21]

0.047 [0.25]

0.188 [1.22]

0.153 [1.00]

0.322c [1.93]

0.327c [1.84]

0.390c [1.78]

0.273 [1.46]

0.226 [1.32]

Restructuring

0.093 [0.30]

0.103 [0.37]

0.187 [0.66]

0.026 [0.09]

0.013 [0.04]

Product Market

0.026 [0.17]

0.049 [0.31]

0.220 [1.24]

0.074 [0.45]

0.024 [0.14]

Intercept Financing Unlocking

0.256c [1.93]

Reacquisition

0.191 [1.36]

0.215 [1.50]

0.135 [0.86]

0.206 [1.12]

0.068 [0.44]

0.091 [0.60]

Pre-Acq Parent Own P 50%

0.278c [1.70]

0.270 [1.66]

0.330b [2.07]

0.463b [2.48]

0.354b [2.28]

0.279c [1.89]

Dual Class

0.297 [1.63]

Same Industry

0.167 [1.09]

Staggered

0.142 [0.92]

0.225 [1.12]

0.110 [0.80]

0.176 [1.30]

0.020 [0.13]

0.118 [0.61]

0.014 [0.09]

0.053 [0.33]

0.156 [1.17]

0.098 [0.73]

Hi-Tech Cash Merger

0.190 [1.17]

0.127 [0.66]

0.251 [1.50]

0.228 [1.35]

Lawsuit

0.032 [0.26]

0.226 [1.58]

0.021 [0.17]

0.047 [0.33]

Log (ECO Age)

0.213 [1.53]

0.159 [1.18]

Performance

0.130 [0.78]

0.159 [0.99]

0.124a [2.87]

Log (ECO-Bidder Size Ratio) Log (Pre-Acq ECO Size)

N Adjusted R2

77 0.09

77 0.08

0.055 [1.33]

0.006 [0.14]

0.054 [1.24]

0.050 [1.15]

77 0.08

52 0.30

77 0.12

77 0.14

Notes: The dependent variable is acquisition premium using the ECO price on 42nd trading day prior to announcement as the base. A description of variables is given in Appendix A. The t-values in brackets below the coefficients are based on heteroskedasticity-standard errors cluster at the parent firm level. a Significance at the 1% level. b Significance at the 5% level. c Significance at the 10% level.

of carve-outs which are acquired by a third-party (N = 45) are 58.4% and 44.1%, respectively. Interestingly, the mean and median acquisition premium for carve-outs which are re-acquired by the parent firms (N = 32) are 30% and 26.6%, respectively. The differences of acquisition premium between third-party acquisition and the parent re-acquisition are statistically significant. These results, at first glance, indicate the possibility of self-dealing by the parent. Considering the small sample size and the previous finding that the acquisition premium is lower when the parent owns majority ownership in a carve-out prior to its merger, we need to test this claim in a multivariate setting before forming a conclusion. 4.5.2. Multivariate analysis In this subsection, we report the results of an ordinary least squares (OLS) analysis assessing the impact of our chosen independent variables on the level of acquisition premium on a subsample of carve-outs which are acquired within 5 years of their IPOs. Our primary specification (Model 1) is

Acquisition Premium 42i ¼ B0 þ B1  Unlocking i þ B2  Reacquisitioni þ B3  Pre  Acq Parent Own P 50%i þ ei

ð4Þ

As shown in Model 1 of Table 9, the coefficient of 0.256 on Unlocking indicates that the level of acquisition premium when the parent’s motive is to unlock the value of a subsidiary is 25.6% higher than the premium paid when the parent’s motive is other than to unlock the value of a subsidiary; the difference is significant at the 10% level (t-value: 1.93). The coefficient of 0.278 on Pre-Acq Parent Own P 50% suggests that carve-outs with majority parent ownership prior to the merger earn a lower acquisition premium to the magnitude of 27.8% than those carve-outs in which the parent firms do not have majority ownership prior to the merger. This difference is statistically significant at the 10% level (t-value: 1.70). The coefficient of 0.191 on Reacquisition indicates that the level of acquisition premium when the parent re-acquires the carved-out subsidiary is 19.1% lower than that when a third-party

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C.A. Desai et al. / Journal of Banking & Finance 35 (2011) 3432–3449 Table 10 Impact of equity carve-out characteristics on re-acquisition and third-party acquisition premiums. ECOs acquired within 5 years of IPO Re-acquisitions

Intercept

Model 2

Model 3

Model 4

Model 5

Model 6

0.294 [1.46]

0.315 [1.25]

0.108 [0.16]

0.705a [4.80]

0.465 [1.65]

1.963 [1.11]

0.061 [0.28]

0.169 [1.22]

0.344 [1.45]

0.415b [1.81]

0.223 [1.30]

0.122 [0.82]

0.364 [1.44]

0.423b [1.75]

0.031 [0.22]

0.139 [1.28]

0.050 [0.25]

0.005 [0.02]

Financing Unlocking

0.242b [1.76]

Product Market Pre-Acq Parent Own P 50%

Third-party acquisitions

Model 1

0.060 [0.26]

Same Industry

0.329b [1.70]

0.068 [0.28] 0.074 [0.45]

0.243 [1.01]

0.076 [0.64]

0.234 [1.08] 0.289 [1.05]

0.335 [1.21]

Staggered

0.157 [1.01]

0.028 [0.11]

Cash Merger

0.365a [2.99]

0.104 [0.36]

Lawsuit

0.230 [1.55]

0.103 [0.43]

Log (Pre-Acq ECO Size)

0.001 [0.02]

0.087 [1.03]

N R2

32 0.08

32 0.09

32 0.42

45 0.08

45 0.15

45 0.16

Notes: This table reports the results of OLS analysis on samples of carve-outs which are either re-acquired by the parent or acquired by the third-party within 5 years of their IPOs. We use Models 1–3 minus variable Restructuring of Table 9 for this analysis. We exclude Restructuring due to limited sample size. The t-values in brackets below the coefficients are based on heteroskedasticity-standard errors cluster at the parent firm level. a Significance at the 1% level. b Significance at the 10% level.

acquires the carve-out; however the difference is statistically insignificant. In Model 2, we include variables pertaining to financing and restructuring motive of the parent in conducting a carve-out, ongoing business relationship, and industry relatedness. We find results similar to those of Model 1. In Models 3–6, we add various controls to assess the robustness of our primary specification. In Model 4, we include the ratio of target and bidder size as one of the controls and find it has a negative relation with the level of acquisition premium. Since there are several non-public acquirers in our sample, our sample size in Model 4 is only 52. In addition, we initially find the impact of our proxy for the carve-out’s market performance (Performance) to be significant on the level of acquisition premium. However, after performing a test identifying influential observations, we find that two observations are dominant in increasing the t-value. When we exclude those two observations, we find the impact of Performance to be insignificant. Therefore, in all our analyses we Winsorize the values of Performance at the one percentile upper level. We do not find consistency in the coefficient sign for our proxy for anti-takeover provision – Staggered. Also, it is statistically insignificant, which suggests that in our sample, we do not find an impact of staggered board on the level of acquisition premium. In addition, as shown in Model 6, the effect of having dual class shares on the level of acquisition premium is statistically insignificant. Overall, the results of OLS on the acquisition premium suggest that the acquisition premium is related to whether the parent has above majority ownership prior to the merger, and whether the parent consummates a carve-out transaction to unlock the value. In all the regressions, we find that in the case of a re-acqui-

sition the estimated acquisition premium is lower than that in the case of a third-party acquisition, but the difference between the two is not statistically significant. We are therefore unable to claim that we have evidence of minority shareholders’ wealth expropriation. In Table 10, we report the results of OLS analyses where we assess the impact of ECO characteristics on acquisition premium for subsamples of parent re-acquired carve-outs and third-party acquired carve-outs. We use the same specifications as those of Table 9, except the variable Restructuring is excluded due to limited sample size. For brevity, we only report results of Models 1–3 of Table 9 in Table 10. As shown in Models 1 and 4 of Table 10, the impact of Unlocking on the level of acquisition premium is the same in both subsamples, except that in the case of re-acquisition the impact is statistically significant at the 10% level. This finding suggests that it is likely that the parent is willing to pay a higher premium if its synergy with the carved-out subsidiary is positive. Similarly, when the parent sells off its remaining portion in a carve-out to a third-party, it negotiates a higher premium because the third-party may have positive synergy with the ECO. The coefficients on Pre-Acq Parent Own P 50% of Models 1 and 4 are worth mentioning. In the case of re-acquisitions, whether the parent owns above majority or below majority ownership in the ECO before the acquisition, the difference in the level of acquisition premium is approximately 6%, and this difference is not statistically significant. However, in the case of third-party acquisitions, when the parent owns above majority ownership in the carve-out the level of acquisition premium is approximately 33% lower than that of the case when the parent has less

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than majority ownership in the ECO prior to merger. This difference is statistically significant at the 10% level. This result seems to contradict the hypothesis that parent firms expropriate wealth from minority shareholders of carve-outs. We also find that the re-acquisitions funded through cash transactions have a higher level of premium than those funded through transactions other than cash.

5. Conclusion Mergers, acquisitions, and divestitures have been a research topic within the corporate restructuring literature for many decades. Equity carve-outs are a unique form of restructuring due to their transient nature. After a few years of their existence, carve-outs usually are either dissolved back into the parent firm or acquired by a third-party. The difficulty of collecting data and the difficulty of distinguishing between the multitude of reasons corporations conduct carve-outs have been an impediment to understanding carve-outs. In this study we endeavor to advance the knowledge of ECOs by manually collecting a large set of ECO data and performing various sets of empirical analyses on the likelihood of acquisition and the level of acquisition premium. We find that certain variables are reliable for predicting the likelihood of ECO’s acquisition in the market. Carve-outs are acquired more rapidly when the parent’s motivation for conducting a carve-out transaction is to unlock the value of the subsidiary, when the parent retains a majority ownership, and when the parent establishes a long term business relationship with the subsidiary. Additionally, we find that there are also reliable predictors of the acquisition premium paid for carve-outs. Acquisition premiums are lower when the parent firms retain majority ownership interests. Overall, our research helps extend knowledge on the acquisition of equity carve-outs. Acknowledgements The authors would like to thank the anonymous referee, the editor (Ike Mathur), Gregory Elliehausen, Bharat Jain, Gergana Jostova, Irvin Morgan, Christo Pirinsky, Robert Savickas, Emanuel Zur, and seminar participants at Florida State University (College of Law), George Washington University, Ohio University, University of Texas-Pan American, Midwest Finance Association (2007), and Southern Finance Association (2009) for their comments and suggestions. Ditina Desai contributed by proofreading the manuscript. This paper is partially based on Desai’s Ph.D. dissertation at The George Washington University. A portion of this research was completed while Desai was at University of Maryland, College Park. All remaining errors are the authors’ responsibility.

Appendix A. Detailed description of explanatory variables A.1. Related to the parent motive (Source: news reports from LexisNexisÒ) Financing takes on a value of one if the parent motive of conducting a carve-out is for financing/investment, and zero otherwise. Restructuring takes on a value of one if the parent conducts a carve-out as a part of restructuring activity, and zero otherwise. Unlocking takes on a value of one if the parent’s intention is to unlock the value of the subsidiary, and zero otherwise. In all the three categories, we conservatively assign a value of zero if the information on the parent motive is not available.

A.2. Related to the parental control on the post-IPO carve-out (Source: SEC filings) Parent Ownership Before is the ownership of the parent in a carve-out before the IPO of the carve-out. Parent Ownership is the ownership of the parent in a carve-out immediately after the IPO of the carve-out. DParent Own is the change in the parent ownership in the carve-out; it is the difference of parent ownership before and after the IPO. Parent Own P 50% takes on a value of one if the parent ownership in the carve-out is above 50% immediately after the IPO, and zero otherwise. Parent Own P 80% takes on a value of one if the parent ownership in the carve-out is above 80% immediately after the IPO, and zero otherwise. Parent Directors is the percentage of carve-out directors who worked for the parent in the past or are currently working for the parent. It also includes directors who are working for both parent and the carve-out. Parent on Audit is equal to one if at least one member of the carve-out audit committee has worked for the parent firm. Parent CEO (Parent Chair) is equal to one if the CEO (Chairperson of the board) of the carve-out has worked for the parent, zero otherwise. Product Market takes on a value of one if the parent and the subsidiary have a buyer–supplier agreement, technology sharing and R&D agreement, marketing and distribution agreement, or specialized service agreement. Financial is the dummy variable that equals one if the parent and subsidiary have a long-term financial agreement. Same Industry is equal to one if the parent and subsidiary operate in the same industry (based on two-digit SIC codes). A.3. Related to anti-takeover provisions and industry structure Staggered, Dual Class, and Delaware take on a value of one if the carve-out has a staggered (classified) board, dual class of shares, and if the carve-out’s incorporate state is Delaware, respectively. We obtain data on anti-takeover provisions from SEC filings. Hi-Tech is a dummy variable that takes on a value of one if the ECO operates in a hi-tech industry. The SIC codes are from SEC filings, LexisNexisÒ, SDC, Compustat, and CRSP, in that order. A.4. Control variables (Source: SEC filings, CRSP) Other Governance related: Blockholder Ownership is the ownership of the blockholders immediately after the IPO of the carve-out. The blockholders are defined as those shareholders other than the parent firm who have 5% or above ownership in a carve-out. Blockholder Own P 5% takes on a value of one if the blockholders’ ownership is above 5%, and zero otherwise. Insider Ownership and CEO Ownership are the post-IPO ownership of insiders (executives + directors) and of the CEO in a carve-out, respectively. Dummy variables Insider Own P 1% and CEO Own P 1% take on a value of one if the insiders and CEO have ownership above 1% in the postIPO carve-out, respectively. Inside Directors is the percentage of ‘true’ executive directors who have exclusively worked for the carve-out firm and have never worked for the parent firm in the past. Outside Directors is the percentage of ‘true’ outside directors who have neither worked for the carve-out nor for the parent firm. Board Size is the number of directors serving on the board. Large Board is the dummy variable that takes on a value of one if the board has seven or more directors, and zero otherwise. CEO Duality is equal to one if the CEO of a carve-out is also the chairperson of the board. Size and performance related: Offer Size is the offer price multiplied by the number of shares offered during the IPO. Size Ratio is the ratio of the market value of the carve-out to the market value of the parent firm, where the market values for both the parent firm and carve-out are computed on the 21st trading day from the IPO date. Performance measures the abnormal return of a

C.A. Desai et al. / Journal of Banking & Finance 35 (2011) 3432–3449

carve-out for the first-year following its IPO. It is the difference of the carve-out buy-and-hold return to that of the return on the value-weighted CRSP index. We exclude the initial day return of a carve-out for computing its buy-and-hold return. A.5. Related to a merger transaction (Source: SEC filings, news reports from FactivaÒ and LexisNexisÒ, and CRSP) Pre-Acq ECO Size is the market value of the carve-out on the 42nd trading day prior to the merger announcement date. ECO-Bidder Size Ratio is the ratio of the market size of the carve-out to that of the bidder firm on the 42nd trading day prior to the announcement date. Cash Merger takes on a value of one if the merger is financed only with cash. Lawsuit takes on a value of one if a lawsuit is filed during the merger deal either by the minority shareholder or other bidder. Multiple Bidder is equal to one if there is more than one bidder competing to acquire the carve-out. Dummy variables Pre-Acq Parent Own P 50%, Pre-Acq Insider Own P 1%, and Pre-Acq Blockholder Own P 5% take on a value of one if the parent’s, insiders’, and blockholders’ ownership prior to the merger announcement are above 50%, 1%, and 5%, respectively. Reacquisition takes on a value of one if the parent re-acquires the carved-out subsidiary. ECO Age is the months between the merger announcement and IPO offer dates. References Allen, J.W., McConnell, J.J., 1998. Equity carve-outs and managerial discretion. The Journal of Finance 53, 163–186. Ambrose, B.W., Megginson, W.L., 1992. The role of asset structure, ownership structure, and takeover defenses in determining acquisition likelihood. Journal of Financial and Quantitative Analysis 27, 575–589. Atanasov, V., Boone, A., Haushalter, D., 2010. Is there shareholder expropriation in the United States? An analysis of publicly traded subsidiaries. Journal of Financial and Quantitative Analysis 45, 1–26. Benou, G., Madura, J., Ngo, T., 2008. Wealth creation from high-tech divestitures. The Quarterly Review of Economics and Finance 48, 505–519. Boone, A., 2003. The Interaction of Ownership, Governance, and Product Markets: Evidence from Equity Carve-outs. Working Paper. University of Kansas. Chemmanur, T.J., Liu, M.H., 2011. Institutional trading, information production, and the choice between spin-offs, carve-outs, and tracking stock issues. Journal of Corporate Finance 17, 62–82. Chemmanur, T.J., Jordan, B.D., Liu, M.H., Wu, Q., 2010. Antitakeover provisions in corporate spin-offs. Journal of Banking & Finance 34, 813–824. Cleves, M.A., Gould, W.W., Gutierrez, R.G., 2004. An Introduction to Survival Analysis Using Stata. A Stata Press Publication, College Station, TX.

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