firm performance and focus: long-run stock market...

*Corresponding author. Tel.: #1-214 7683185.

E-mail address: [email protected] (H. Desai)qWe thank Je! Allen, Randy Beatty, Rick Boebel, Richard Brealey, Steve Byers, Robin Clement,

Chitru Fernando, Charles Hadlock, Dave Harvey, Chris Higson, Ron Lease, Narayan Naik, LynnRees, Jay Ritter, Russ Robins, Paul Spindt, Wayne Shaw, K. Srinivasan, Mike Vetsuypens, TracieWoidtke, Shuang Wu and seminar participants at Case Western Reserve University, GeorgetownUniversity, London Business School, Southern Methodist University, Tel Aviv University, TexasA&M University, Tulane University, the 1997 Financial Management Association annual meetingsand the 1997 Bu!alo Conference on Financial Economics and Accounting for their comments andCommerce Clearing House for allowing us the use of their library. We are particularly grateful to ananonymous referee whose suggestions have greatly improved this paper.

Journal of Financial Economics 54 (1999) 75}101

Firm performance and focus: long-run stockmarket performance following spino!sq

Hemang Desai!,*, Prem C. Jain"

!Cox School of Business, Southern Methodist University, Dallas, TX 75275, USA"Freeman School of Business, Tulane University, New Orleans, LA 70118, USA

Abstract

We examine whether an increase in focus is an explanation for the stock market gainsassociated with spino!s. For a sample of 155 spino!s between the years 1975 and 1991,we "nd that the announcement period as well the long-run abnormal returns for thefocus-increasing spino!s are signi"cantly larger than the corresponding abnormal re-turns for the non-focus-increasing spino!s. The results for the change in operatingperformance are consistent with those for the stock market performance. Cross-section-ally, the stock market performance as well as the operating performance are positivelyassociated with change in focus. An analysis of the non-focus-increasing spino!s showsthat the "rms are likely to undertake these spino!s to separate underperforming subsidia-ries from the parents. ( 1999 Elsevier Science S.A. All rights reserved.

JEL classixcation: G14; G32

Keywords: Spino!; Divestiture; Focus; Long-run performance; Operating performance

0304-405X/99/$ - see front matter ( 1999 Elsevier Science S.A. All rights reserved.PII: S 0 3 0 4 - 4 0 5 X ( 9 9 ) 0 0 0 3 2 - X

1Lang et al. (1991) provide empirical support for Jensen (1986)'s argument and show that "rmswith high level of free cash #ows tend to make poor acquisitions.

2 In general, both sello!s and spino!s have been known to elicit a positive stock market reaction,on average. For the studies of the market reaction to the announcement of spino!s, see Hite andOwers (1983), Miles and Rosenfeld (1983), Schipper and Smith (1983) and Allen et al. (1995). For thestudies of the market reaction to the announcement of sello!s, see Alexander et al. (1984), Jain (1985),Klein (1986) and Hite et al. (1987).

1. Introduction

Focusing on core business through restructuring has received an increasedattention by "rms in the recent years (Comment and Jarrell, 1995). Firmsgenerally increase focus by selling unrelated assets to others or by spinning o!unrelated divisions to their own shareholders. While an increase in focus couldtake place through either a sale of assets or a spino!, there are some inherentadvantages in concentrating on a sample of spino!s. Since a seller receives cashin an asset sale, asset sales are often motivated by liquidity constraints ora desire to pay down debt. Unlike the sale of assets, a spino! does not involveexchange of any cash. Thus, a spino! is not motivated by the company's desireto generate immediate cash. Asset sales often become a source of liquidity for"nancially distressed "rms (Shleifer and Vishny, 1992; Ofek, 1993; and Langet al., 1995). Lang et al. (1995) and John and Ofek (1995) argue that asset salescan also be undertaken when they provide the cheapest source of funds, notnecessarily to improve e$ciency. Also, an asset sale may take place in case thebuyer is willing to pay a high price } presumably because the buyer has betteruse of the assets or is willing to overpay for some reason such as excess free cash#ow (Jensen, 1986).1 A study of spino!s is free from such confounding e!ects.Furthermore, spino!s, on average, are associated with a substantially higherincrease in focus compared to sello!s. Finally, in the case of a spino!, both theparent and the subsidiary trade as separate entities subsequent to the spino!and, therefore, their performance can be analyzed separately. This is not feasiblein the case of sello!s.2

We use a sample of spino!s to provide evidence on association betweenincrease in focus and the stock market performance as well as the operatingperformance. There are several reasons to expect a di!erential performanceacross the focus-increasing and the non-focus-increasing spino!s. A focus-increasing spino! reduces the diversity of assets under management and therebyincreases the e$ciency of the manager. Poorly performing divisions are oftensustained in diversi"ed "rms through cross-subsidies (Meyer et al., 1992).Cross-subsidies have been shown to contribute to value losses in diversi"ed"rms (Berger and Ofek, 1995). A spino! can eliminate these cross-subsidies byseparating unrelated lines of business.

76 H. Desai, P.C. Jain / Journal of Financial Economics 54 (1999) 75}101

3For a long-run study providing evidence on under-reaction to initial public o!ers, see Ritter(1991), to mergers, see Agrawal et al. (1992), to share repurchases, see Ikenberry et al. (1995), toequity issues, see Loughran and Ritter (1995) and Spiess and A%eck-Graves (1995), to dividendinitiations and omissions, see Michaely et al. (1995), and to stock splits, see Ikenberry et al. (1996)and Desai and Jain (1997).

We study a sample of 155 spino!s completed between 1975 and 1991. Forannouncement period abnormal returns, Daley et al. (1997) "nd that the focus-increasing spino!s are associated with larger announcement period abnormalreturns than the non-focus- increasing spino!s. However, they do not studylong-run stock market performance. Given the evidence on the long-run perfor-mance following spino!s (Cusatis et al., 1993) and other "rm speci"c events, thefull impact of the managerial action is likely to be captured only througha long-run study.3 Hence, we analyze the post-spino! long-run stock marketperformance (up to 36 months) to examine the di!erence between the perfor-mance of the focus-increasing and the non-focus-increasing spino!s.

To identify the source of abnormal stock market performance and to testwhether an increase in focus improves operating e$ciency, we examine thechange in operating performance (operating cash #ow to total assets) around thespino!s. Similar to Daley et al. (1997), we "nd that, on average, focus-increasing"rms exhibit superior operating performance following spino!s. Daley et al.,however, do not relate focus to performance to provide evidence of a directassociation between change in focus and performance. We use cross-sectionalregressions to provide evidence of direct association between change in focusand performance.

Most discussion in the literature centers around the argument that focus-increasing spino!s are undertaken to enhance operating e$ciency. However,motivations for undertaking non-focus-increasing spino!s have received littleattention. We analyze the sample of non-focus-increasing spino!s in detail tounderstand their motivations. In particular, we examine whether non-focus-increasing spino!s are preceded by high levels of debt or "nancial distress. Wealso examine whether parents undertake these spino!s to transfer a dispropor-tionate amount of debt to the subsidiaries. Finally, we examine whether non-focus-increasing spino!s are undertaken to separate the underperformingsubsidiaries from their parents.

Our results are as follows. Similar to Daley et al. (1997), the three-dayannouncement period abnormal returns are signi"cantly larger for the focus-increasing spino!s (4.45%) than for the non-focus-increasing spino!s (2.17%).However, we show that the superior performance of the focus-increasingspino!s persists in the post-spino! period. In particular, the abnormal returns(based on size and industry matched control "rms) for the focus-increasing "rmsare statistically signi"cant 11.12%, 20.77% and 33.36% over holding periods of

H. Desai, P.C. Jain / Journal of Financial Economics 54 (1999) 75}101 77

one, two and three years following the spino!s. The corresponding abnormalreturns for the non-focus-increasing "rms are statistically insigni"cant!0.96%, !7.66% and !14.34%. The results are similar when the parentsand the subsidiaries are examined separately. The results are not driven by the"rms that were taken over following spino!s as the results are similar when theanalysis is replicated for the "rms that did not experience any takeover activitywithin the three years following the spino!s. Finally, the results are robust to theuse of alternative de"nitions of focus and to the use of a number of alternativebenchmarks for computing abnormal returns.

Cross-sectionally, the change in operating performance is signi"cantly posit-ively associated with the change in focus. Furthermore, the announcementperiod abnormal returns are signi"cantly positively associated with the changein focus and the change in operating performance. Thus, the stock marketperformance results are corroborated by the operating performance results.

For the non-focus increasing spino!s, however, e$ciency does not appear tobe the main motive as there is no evidence of an improvement in operatingperformance following the spino!s. Following Lang et al. (1995), we examine"nancial leverage and interest coverage ratio to investigate whether these "rmsare in "nancial distress. There is no evidence that spino!s are motivated by highlevel of "nancial leverage or "nancial distress. Also, we do not "nd any evidenceof disproportionate transfer of debt from the parents to the subsidiaries througha spino!. We show that the "rms that undertake non-focus-increasing spino!sare spinning o! poorly performing subsidiaries.

The rest of the paper is organized as follows. Section 2 describes the sampleand presents the summary statistics. Section 3 describes the methodology usedto compute abnormal returns. The results of the stock market performance andthe operating performance are presented in Sections 4 and 5, respectively.Section 6 presents the results from a cross-sectional regression analysis. Themotivations of the "rms in the non-focus-increasing sample are analyzed inSection 7. Section 8 concludes the paper.

2. De5nition and sample selection

2.1. Dexnition

A spino! is de"ned as a pro-rata distribution of the shares of the subsidiary tothe parent's shareholders. A spino! creates a new entity that trades indepen-dently of its former parent. A spino! is tax free if it satis"es the following criteriaset forth in Section 355 of the IRS code: (1) The distribution must constitute atleast 80% of the outstanding shares of the subsidiary, and the shares retained bythe parent should not constitute a &practical control' of the subsidiary; (2) boththe parent and the subsidiary must be engaged in an active trade or business for


at least "ve years prior to the ex-date; and (3) the transaction is done for soundbusiness reasons and not as a means of avoiding taxes. Although we de"ne thespino! as above, the popular press may refer many other forms of reorganiza-tions as spino!s. A split-up is a distribution of the shares of all the subsidiariesthat comprise the "rm, thus the parent ceases to exist upon the completion of thetransaction. In a split-o!, parent's shareholders have to exchange the shares ofthe parent to obtain the shares in the subsidiary. In an equity carveout, theparent sells some of the shares of the subsidiary to the public and, therefore,a carve-out is distinct from a spino! as the parent receives cash in a carveout.Also, unlike a spino!, the parent usually retains a controlling interest in thesubsidiary. In this paper we study only the tax-free spino!s.

2.2. Sample selection

The sample covers the period from 1975 to 1991. The initial sample isgathered from three sources. The Center for Research in Security Prices (CRSP)tapes provide the "rms with dividend distribution codes of 3763, 3764, and 3765.A search of the Dow Jones News Service (DJNS) for key words spinow, spin-owand spin ow, and the Standard & Poor's Dividend Record for stock dividendspaid in other "rms provide our sample. We use the original articles in the WallStreet Journal (WSJ) to verify the announcement dates and the nature of thedividend. The initial sample consists of 246 parents and their 257 subsidiariesthat are also available on the CRSP tapes. We then consult the CommerceClearing House's Capital Changes Reporter (CCR) to determine the tax status ofthe above distributions. We eliminate 30 spino!s that were taxable and9 spino!s for which enough information was not available in the WSJ or theCCR to classify the transaction as a spino!. In addition, 17 spino!s areeliminated because they were either Royalty Trusts, Real Estate InvestmentTrusts or Limited Partnerships, as these types of spino!s are usually motivatedby tax reasons. We also eliminate 8 cases where the subsidiary was trading priorto the spino!. Finally, we eliminate 27 spino!s where the parent stopped tradingas of the ex-date because the spino! was undertaken to facilitate the parent'smerger with some other "rm. Thus, our "nal sample consists of 155 parents thatspun o! 162 subsidiaries in tax free transactions.

2.3. Measures of focus

We use three alternative measures of focus to divide the overall sample intofocus-increasing and non-focus-increasing spino!s. We use Compustat segmentdata tapes as well as annual reports to obtain data on sales revenue of individualsegments. The "rst measure of focus, Her"ndahl index, H

ifor "rm i is computed

as the sum of squares of each segment's sales revenue as a proportion of totalsales revenue. We classify a spino! to be a focus-increasing spino! if there is an


4Note that the accounting standard requiring disclosure of segment data (SFAS 14) was issued in1976 and was to be e!ective for the "scal years ending after December 1977. In fact, segment data aregenerally available only after "scal year 1978. Thus, for the spino!s occurring in the early part of oursample period, we are unable to classify them using the change in Her"ndahl index.

increase in the Her"ndahl index of the parent from the year prior to theannouncement of the spino! to the year of the spino!. The second measure offocus is given by the number of segments reported by the "rm. If there isa decrease in the number of segments reported by the parent from the yearbefore the announcement to the year of the spino!, the spino! is classi"ed asa focus-increasing spino!. In the third measure of focus, a spino! is consideredto be a focus-increasing spino! when the two-digit SIC code of the subsidiary isdi!erent from the two-digit SIC code of the parent. Since the results across thethree measures of focus are similar, most results are reported using the change inHer"ndahl index as the measure of focus.

For 130 "rms (out of a total of 155 "rms), sales revenue data are available oneither the Compustat segment data tapes or in the annual reports of the "rms.Using Her"ndahl index as the de"nition of focus, we classify 92 of the 130spino!s as focus increasing spino!s. The classi"cation of a spino! into focus-increasing or non-focus-increasing is robust as about 90% of the classi"cationsare insensitive to the de"nition of focus used. For 25 "rms for which Compustatsegment data tapes or the annual reports do not provide sales revenue data bysegments, we are unable to compute the Her"ndahl index.4 However, to maxi-mize the use of the sample in the ensuing analysis, we classify them as eitherfocus-increasing or non-focus-increasing by reading the actual news stories fromthe WSJ and DJNS as well as the information gathered from the annual reportsand other sources. In most cases, it is not di$cult to classify them. Of the 25"rms, 19 are classi"ed as focus-increasing and the remaining 6 are classi"ed asnon-focus-increasing. Thus, from the full sample of 155 spino!s, 111 are classi-"ed as focus-increasing and the remaining 44 are classi"ed as non-focus-increasing. Our results are similar when we restrict our analysis to the sample of130 "rms (instead of the full sample of 155 "rms) for which segment data areavailable.

2.4. Summary statistics

Table 1 reports the distribution of the ex-date (completion of the spino! ) ofthe sample "rms by year. The focus-increasing spino!s do not appear to beconcentrated in a few years. For the non-focus-increasing spino!s, there appearsto be some (although not extreme) clustering in time. We note that 40.9% of thenon-focus-increasing spino!s (18 out of 44) occur over a period of four yearsfrom 1979 to 1982 (23.5% of the sample time period), a time period when theeconomic conditions were poor. This indicates that the non-focus-increasing


Table 1Distribution of spino!s by year

This table reports the distribution by year of completion of the full sample of 155 spino!s as well asthe focus-increasing (111 spino!s) and non-focus-increasing (44 spino!s) subsamples. The focus-increasing sample comprises those "rms that either had an increase in sales based Her"ndahl index(92 "rms) or in the case of non-availability of sales data, additional information indicated that thespino! increased the focus of the "rm (19 "rms). Additional information was compiled from annualreports, news items in the Wall Street Journal and an examination of the industries of the parentsand the subsidiaries. The remaining 44 spino!s are classi"ed as non-focus-increasing

Year Fullsample

Focus-increasingsample

Non-focusincreasingsample

Year Fullsample

Focus-increasingsample

Non-focusincreasingsample

1975 5 4 1 1984 14 10 41976 4 4 0 1985 12 9 31977 2 2 0 1986 9 8 11978 3 3 0 1987 11 6 51979 9 5 4 1988 16 13 31980 9 6 3 1989 11 8 31981 15 9 6 1990 8 6 21982 8 3 5 1991 7 6 11983 12 9 3 Total 155 111 44

5Assigning deciles relative to the NYSE/AMEX universe of "rms is more meaningful as it createsa wider dispersion in size across deciles.

spino!s may be undertaken in response to economic or "nancial distress. Weaddress this issue in detail later in Section 7.

We also examine the sample for industry clustering. In general, we do not "ndindustry clustering in spino!s. The 111 focus-increasing spino!s are in 40di!erent industries (two-digit SIC codes). The largest concentration is in theChemicals and Allied Products industry (SIC code 28) with ten spino!s. Sim-ilarly, the 44 non-focus-increasing spino!s are in 23 di!erent industries. About68% of the parents (105 out of 155) trade on the New York Stock Exchange(NYSE), while a large proportion of the subsidiaries (about 60% or 97 out of162) trade on the Nasdaq. The mean (median) number of trading days betweenthe announcement day and the ex-day is 133 (111) days.

Panel A of Table 2 reports summary statistics for the combined "rm onemonth prior to the announcement of the spino!. The mean (median) size interms of the market value of equity (in 1995 dollars) of the parents is $1302.99million ($306.09 million). Their mean (median) size decile ranking is 6.66 (7.00)where decile 10 corresponds to the largest "rms. The deciles are assigned relativeto all the NYSE/AMEX "rms.5 Thus, the "rms announcing spino!s tend to be


Table 2Summary statistics for the parents and the subsidiaries

The following table reports several summary statistics for the sample of 155 parents and their 162subsidiaries created through spino!s between 1975 and 1991. The market value of the parent priorto the spino! is the market value of equity one month prior to the month of announcement date (orex-date if the announcement date is missing). The market value of the parents and the subsidiariesfollowing the spino! is measured at the end of the "rst month following the spino!. Break-points forsize decile ranks are assigned relative to the universe of NYSE/AMEX "rms on CRSP. Each monthall the NYSE/AMEX "rms on CRSP are sorted into ten size deciles based on their market value ofequity, with decile 10 corresponding to the largest "rms. Break points for the book-to-marketquintile ranks are similarly assigned relative to the universe of NYSE/AMEX "rms on CRSP andCompustat. Each size decile is sorted into book-to-market quintiles with a rank of 5 correspondingto high book-to-market (value) "rms. We avoid look ahead bias by requiring a gap of at least4 months before using the book value of equity from Compustat. Firms are then assigned a sizedecile ranking and a book-to-market quintile ranking each month using the above break points.Beta is the Scholes-Williams (1977) beta computed using the NYSE/AMEX equal-weighted index.The beta in the pre-spino! period is estimated over 250 d from day !300 to day !51 relative tothe announcement day and the post-spino! beta is also estimated over 250 d from day #51 to day#300 relative to the ex-date. Data for at least 50 trading days are required to compute beta

Variable No. of obs. Mean Median Std. dev

Panel A: Parents one month prior to the month of announcement of the spinow

Mkt. value (million of 1995 dollars) 155 1302.99 306.09 2426.23Size decile rank 155 6.66 7.00 2.61Book-to-market quintile rank 135 2.77 3.00 1.36Beta 143 1.17 1.20 0.48

Panel B: Parents after spinows (at the end of the month of ex-date of the spinow )


Panel C: Subsidiaries after spinows (at the end of the month of ex-date of the spinow )


large "rms. The mean (median) Scholes-Williams beta (relative to CRSPNYSE/AMEX equal-weighted index) of the "rms prior to the spino! is 1.17(1.20). The mean (median) book-to-market equity quintile ranking of 2.77 (3.00)does not suggest that the "rms are substantially di!erent from an average "rmon the CRSP and Compustat tapes on this dimension.


6Note that these mergers or takeovers are di!erent from the ones that are announced along withthe spino! announcement and are completed on the ex-date itself.

Panels B and C of Table 2 report the summary statistics for the parents andthe subsidiaries, respectively, immediately following the spino!s (end of themonth of ex-date). As expected, the mean (median) size as well as the size decilerankings of the parents is lower following the spino!s. The mean (median)size decile ranking of the parents is 6.19 (6.00). As for the subsidiaries, they aresmaller than the parents with the mean (median) market value of equity of$271.19 million ($54.74 million). The mean (median) size decile of the subsidia-ries is 4.24 (4.00). Since most of the summary statistics for the subsamples of thefocus-increasing and the non-focus-increasing spino!s are similar, we do notreport the summary statistics separately.

The mean (median) percentage spun o! (not reported in the table) is 28.99%(18.46%), indicating that, on average, the "rms undertaking spino!s in oursample spin o! a large portion of their assets. For the two subsamples of thefocus-increasing and the non-focus-increasing spino!s, the mean (median) per-centage spun o! are 30.84% (20.94%) and 24.33% (11.54%), respectively.

Cusatis et al. (1993) show that both the parents and the subsidiaries experi-ence increased takeover activity following spino!s. Similar to their sample, we"nd (not reported in the table) that in our sample, 18 parents and 17 subsidiaries(about 11% of the total sample of 317 parents plus subsidiaries) either merged orwere taken over in the 36 months following the ex-month. In two cases, both theparents as well as the subsidiaries were taken over.6

2.5. Change in the herxndahl index and the number of segments around spinows

Table 3, Panel A presents the mean and the median Her"ndahl index in theyear prior to the announcement and the year of spino!. The mean Her"ndahlindex increases from 0.5917 to 0.7535, an increase of 0.1618 which is signi"cantlydi!erent from zero (t-statistic of 8.95). The median increase is 0.0916 and is alsosigni"cant. Thus, spino!s, on average, are associated with a signi"cant increasein focus. As mentioned earlier, the average change in focus achieved throughspino!s is much higher than that achieved through sello!s. John and Ofek(1995) report that the mean (median) change in Her"ndahl index around sello!sis only 0.032 (0.000). Thus, spino!s seem to present a more appropriate sampleto study a focus-increasing managerial action. Panel B of Table 3 presents theresults for the change in the number of segments. The mean (median) number ofsegments prior to the spino!s is 3.14 (3.00) which declines to 2.30 (2.00) after thespino!s. The mean (median) change of !0.84 (!1.00) is highly signi"cant(t-statistic of !8.04). Once again, the change in the number of segmentsfollowing spino!s is substantially larger than the change following asset sales.


Table 3Change in focus around spino!s

Panel A reports the change in sales based Her"ndahl index from the year before the announcement ofspino! to the year of spino! for the entire sample. Panel B reports the change in the number ofsegments reported by the company over the same period for the entire sample. The signi"cance of themean is determined using a t-test and that of the median is determined using Wilcoxon sign-rank test

Time period No. of obs. Mean Median Std. dev.

Panel A: Change in Herxndahl index for the entire sample

One year prior to announcement 130 0.5917 0.5370 0.2562Year of completion 130 0.7535 0.8944 0.2770Change 130 0.1618*** 0.0916*** 0.2061

Panel B: Change in the number of segments for the entire sample

One year prior to announcement 132 3.14 3.00 1.61Year of completion 132 2.30 2.00 1.61Change 132 !0.84*** !1.00*** 1.02

Note: One, two and three asterisk(s) in superior indicate(s) &signi"cant di!erence' from zero at the10%, 5% and 1% level, respectively, using a two-tailed test.

For example, in John and Ofek (1995), the mean (median) change in number ofsegments associated with asset sales is !0.137 (0.000). Conclusions in this paperare not a!ected from using alternative de"nitions of focus.

3. Methodology

The abnormal returns are computed as buy-and-hold or holding-periodabnormal returns using a matching "rm methodology. In particular, we selectfour matching "rms for each parent and each subsidiary in our sample. Thematching "rms selected are the ones that are closest to the sample "rm in size(two larger than the sample "rm and two smaller than the sample "rm) and havethe same two-digit SIC code as that of the sample "rm in the month of theex-date. Of the two closest matching "rms (one large and one small), one of themis randomly designated as the "rst matching "rm and the other is designated asthe second matching "rm. The remaining two matching "rms are then desig-nated as the third and the fourth matching "rms. The stock market return on thesample "rm is then compared against the return on the "rst matching "rm. If the"rst matching "rm should disappear for some reason, we use the secondmatching "rm from that point on and then the third and so on. If the sample"rm disappears, then we assume that the proceeds are invested in its matching"rm from that point on. We also select matching "rms based on a four-digit SIC


code. Although the four-digit match yields similar results, we present resultsbased on the two-digit match as the matching "rms based on the two-digitmatch are closer in size to the sample "rms.

The statistical signi"cance of the average holding period abnormal return(AHAR

T) for any given holding period ¹ (for example, 12 months) is determined

using the t-statistic which is computed as

t"AHART/SE

T

where SET

is the cross-sectional standard error of AHART. Barber and Lyon

(1997) and Kothari and Warner (1997) show that the signi"cance levels in theanalysis of long-horizon returns are biased when certain procedures are used tocompute abnormal returns. However, Barber and Lyon (1997) speci"callyanalyze the matching "rm procedure (they call it the control "rm approach) and"nd that the signi"cance levels and the t-statistics computed using a matching"rm methodology are well speci"ed in random samples.

As a robustness check, we compute abnormal returns using four additionalbenchmarks. For the "rst benchmark, we select a single matching "rm from thesame four-digit SIC code that is closest in size to the sample "rm in the month ofex-date. If a four-digit match is not available, a two-digit match is selected. If thematching "rm should disappear, then its return is replaced with that of the CRSPequal-weighted index from that point on. For the second benchmark, we computethe abnormal returns relative to the CRSP equal-weighted index. The third andthe fourth benchmarks are the CRSP value-weighted index and a size and book-to-market based control portfolio, respectively. Since the results are similaracross all the four alternative benchmarks, we do not report them in the paper.

Since a spino! involves a pro-rata distribution of the shares of the subsidiary,we create a pro-forma combined "rm following the spino! by weighting thereturn of the parent and that of its subsidiary using their market values of equityat the end of the month of ex-date. This gives us the return that an investorwould have realized had the investor held on to the shares of both the parentand the subsidiary following the spino!. The benchmark portfolio's return iscreated by weighting the return of the parent's matching "rm and the subsidi-ary's matching "rm in the pre-spino! period as well as the post-spino! periodusing the above weights. We also report the results for the parents and theirsubsidiaries separately.

4. Stock market performance around spino4s

4.1. Announcement period abnormal returns

Table 4 reports the results for a three-day window around the announcementday. The market reacts signi"cantly to the announcement of a spino!, on


Table 4Announcement period abnormal returns for the focus-increasing and the non-focus-increasingsample

This table reports the 3 day announcement period (day !1 to #1) raw returns for the sample "rms(RA=F), corresponding returns to CRSP equal-weighted index (MK¹) and abnormal returns (AR)along with t-statistic and percentage of positive abnormal returns (%#ve) for the entire sample andthe focus-increasing and the non-focus-increasing sub-samples. The focus-increasing sample com-prises "rms that either had an increase in their sales based Her"ndahl index from one year before theannouncement of spino! to the year of completion of the spino! or an analysis of the "rms' annualreports, news items and an examination of the industries of the parents and the subsidiariesindicated that the spino! increased the focus of the parent. The remaining sample is classi"ed as thenon-focus-increasing sample. Fewer number of observations result due to missing announcementdates

Sample No. of obs. RAWF (%) MKT (%) AR (%) t-Stat %#ve

All "rms 144 3.85 0.01 3.84 6.54*** 70.8Focus increasing sample 103 4.46 0.01 4.45 6.34*** 77.7Non-focus increasing sample 41 2.34 0.17 2.17 2.17*** 53.7


7The abnormal returns for the three-day window are relative to the CRSP equal-weighted index.Abnormal returns for short windows are generally not sensitive to the benchmark.

average, as evidenced by signi"cant abnormal returns of 3.84% (t-statistic of6.54) for a three-day window (day !1 to #1) around the announcement ofspino!s.7 Consistent with the results in Daley et al. (1997), the three-dayannouncement period abnormal returns for the focus-increasing "rms are4.45% (t-statistic of 6.34) while the abnormal returns for the non-focus-increas-ing "rms are 2.17% (t-statistic of 2.17). The di!erence in the announcementperiod abnormal returns of the two samples (2.26%) is also statistically signi"-cant (t-statistic of 1.82). These results show that the information conveyedthrough a focus-increasing spino! has a stronger impact on the stock prices thanthe information conveyed through a non-focus-increasing spino!.

4.2. Performance of the pro-forma combined xrms before the spinows

Table 5 reports the results for the pro-forma combined "rms. The results inPanel A show that in the pre-spino! period, the abnormal returns for the "rmsin the overall sample, on average, are close to zero. For the focus-increasingspino!s, the prior period (month !36 to !1) average abnormal return is6.91% (Panel B) while it is !18.05% for the non-focus increasing spino!s


Table 5Stock market performance of the pro-forma combined "rm

Raw buy-and-hold returns of the sample "rms (RA=F), raw buy-and-hold returns of the bench-mark portfolio (RA=P), the abnormal returns (AHAR), the t-statistic associated with the abnormalreturns and the percentage of positive abnormal returns (%#ve) over several periods are reportedfor the full sample of parents and their corresponding subsidiaries as well as for the focus-increasingand non-focus-increasing sub-samples. The focus-increasing sample comprises those "rms thateither had an increase in sales based Her"ndahl index or an analysis of the annual reports, newsitems and an examination of the industries of the parents and the subsidiaries indicated that thespino! increased the focus of the "rm. The remaining sample is classi"ed as the non-focus-increasingsample. In the post-spino! period (following ex-date) the returns of the parents and the subsidiariesare combined in proportion of their market value of equity at the end of the month of ex-date. Thebenchmark portfolio is the return to a matching "rm selected based on size (market value of equity)and 2 digit SIC code in the month of the ex-date. If the matching "rm disappears then its return isreplaced with a second matching "rm also selected in the month of ex-date and so on till all the fourmatch "rms are exhausted, after that return of CRSP equal weighted index is used. If the sample "rmdisappears, then its return is replaced with the return of the benchmark portfolio from that point on.AM is the month of the announcement date. EX is the month of the ex-date. There are fewerobservations in the pre-spino! period due to missing announcement dates or missing returns data

Time period No. of obs. RAWF (%) RAWP (%) AHAR (%) t-Stat %#ve

Panel A: All xrms

AM!36 to AM!1 145 94.47 94.79 !0.32 !0.02 59.3AM!24 to AM!1 145 53.15 55.19 !2.04 !0.19 54.5AM 145 5.58 1.76 3.82 3.16*** 66.2AM#1 to EX!1 146 7.64 6.35 1.29 0.48 47.9EX 155 3.82 2.90 0.92 0.59 56.1EX#1 to EX#12 155 21.68 13.99 7.69 1.62 60.6EX#1 to EX#24 155 46.64 33.94 12.70 1.46 60.6EX#1 to EX#36 155 71.22 51.39 19.82 2.17*** 58.7

Panel B: Focus-increasing xrms

AM!36 to AM!1 103 102.40 95.49 6.91 0.27 65.1AM!24 to AM!1 103 56.04 53.67 2.37 0.17 56.3AM 103 5.56 0.77 4.80 3.34*** 68.9AM#1 to EX!1 104 9.61 8.29 1.32 0.38 45.2EX 111 3.60 1.64 1.96 0.99 61.3EX#1 to EX#12 111 23.17 12.06 11.12 2.02*** 65.8EX#1 to EX#24 111 48.74 27.97 20.77 1.97*** 64.9EX#1 to EX#36 111 79.68 46.32 33.36 3.19*** 63.9

Panel C: Non-focus-increasing xrms

AM!36 to AM!1 42 75.03 93.08 !18.05 !0.75 45.2AM!24 to AM!1 42 46.08 58.92 !12.84 !0.79 50.0AM 42 5.61 4.19 1.42 0.64 59.5AM#1 to EX!1 42 2.75 1.55 1.20 0.35 54.8EX 44 4.36 6.06 !1.70 !0.76 43.2EX#1 to EX#12 44 17.90 18.86 !0.96 !0.10 47.7EX#1 to EX#24 44 41.34 49.00 !7.66 !0.51 50.0EX#1 to EX#36 44 49.87 64.20 !14.34 !0.82 45.5



(Panel C). Although these abnormal returns are statistically not signi"cant, theyare reasonably large and are of opposite sign.

4.3. Performance of the pro-forma combined xrms after the spinows

Following the completion of the spino!s (following the month of ex-date) thepro-forma combined "rms outperform the matching "rms for holding periods ofup to three years (Table 5, Panel A). The average abnormal return in the "rstyear following the spino!s (month #1 to month #12) is 7.69% (t-statistic of1.62). For holding periods of two years (24 months) and three years (36 months),the abnormal returns are 12.70% (t-statistic of 1.46) and 19.82% (t-statistic of2.17), respectively. Although the above returns are large in magnitude, only theabnormal returns for the three year holding period are signi"cant. More inter-estingly, we show below that in the post-spino! period of three years, theperformance of the focus-increasing spino!s is substantially di!erent from thatof the non-focus-increasing spino!s.

Panel B of Table 5 reports the results for the 111 focus-increasing "rms. Thefocus-increasing "rms earn positive and signi"cant abnormal returns of 11.12%(t-statistic of 2.02) in the "rst year following the spino!s. The abnormal returnsfor holding periods of two years and three years are 20.77% (t-statistic of 1.97)and 33.36% (t-statistic of 3.19), respectively. The last column in Panel B showsthat the percentage of "rms earning positive abnormal returns is about 64%,indicating that the above results are not driven by a few large observations. Notethat the two- and the three-year abnormal returns are not driven by theabnormal performance in the "rst year alone. The abnormal returns in years twoand three are 8.74% (t-statistic of 1.93) and 6.56% (t-statistic of 1.01), respectively.

An examination of the raw returns shows that the focus-increasing "rms earnlarge raw returns of 23.17%, 48.74% and 79.68% for holding periods of one, twoand three years, respectively. Thus, the results for the focus-increasing "rms arenot expected to be sensitive to the choice of the benchmark. However, weexplicitly test for this possibility and "nd that the results are robust to the use ofalternative benchmarks.

Panel C of Table 5 reports the results for the non-focus-increasing "rms.Overall, in contrast with the results for the focus-increasing "rms, the abnormalreturns for the holding periods of one to three years (!0.96%, !7.66% and!14.34%) are negative but statistically insigni"cant.

A comparison of the performance of the focus-increasing "rms to that of thenon-focus-increasing "rms shows that the focus-increasing "rms outperform thenon-focus-increasing "rms by 12.08% (t-statistic of 1.15), 28.43% (t-statistic of1.48) and 47.70% (t-statistic of 2.39) over holding periods of one, two and threeyears, respectively. The above results show that the focus-increasing "rms, onaverage, have enhanced the wealth of their shareholders. We next examine theperformance of both the parents and the subsidiaries separately to test whether


Table 6Stock market performance of the parents following spino!s

Raw buy-and-hold returns for the sample "rms (RA=F), raw buy-and-hold return of the bench-mark portfolio (RA=P), the abnormal return (AHAR), the t-statistic associated with the abnormalreturns and the percentage of positive abnormal returns (%#ve) over several periods following themonth of ex-date are reported for the entire sample of parents as well as the focus-increasing and thenon-focus-increasing parents. The focus-increasing sample comprises those parents that either hadan increase in sales based Her"ndahl index or an analysis of the annual reports, news items and anexamination of the industries of the parents and the subsidiaries indicated that the spino! increasedthe focus of the "rm. The remaining sample is classi"ed as the non-focus-increasing sample. Thebenchmark portfolio return is the return to a matching "rm matched on size (market value of equity)and 2-digit SIC code in the month of ex-date. If the "rst matching "rm disappears, then its return isreplaced with a second matching "rm also selected in the month of ex-date. Once all the fourmatching "rms are exhausted, the return on the CRSP equal-weighted index is used from that pointon. If the sample "rm disappears, then the proceeds are assumed to be invested in the benchmarkportfolio. EX is the month of the ex-date. Panel A reports the results for all parents, Panel B reportsthe results for the focus-increasing parents and Panel C reports the results for the non-focus-increasing parents


Panel A: All parents

EX#1 to EX#12 155 23.56 17.06 6.51 1.21 55.5EX#1 to EX#24 155 47.13 36.55 10.58 1.05 58.1EX#1 to EX#36 155 71.73 56.55 15.18 1.42 60.0

Panel B: Focus-increasing parents

EX#1 to EX#12 111 23.75 16.96 6.79 1.01 57.7EX#1 to EX#24 111 47.72 30.19 17.54 1.44 59.5EX#1 to EX#36 111 76.17 50.80 25.37 2.15** 63.9

Panel C: Non-focus-increasing parents

EX#1 to EX#12 44 23.10 17.31 5.79 0.68 50.0EX#1 to EX#24 44 45.64 52.59 !6.95 !0.40 54.5EX#1 to EX#36 44 60.54 71.05 !10.51 !0.45 50.0


the superior performance of the focus-increasing "rms is due to the parents, thesubsidiaries, or both.

4.4. Performance of the parents

Table 6 reports the results of the parents following the spino!s. Panel Areports the results for all the parents. The results show that the parents earn


8The mean (median) Her"ndahl index for the subsidiaries in the year of the spino! is 0.86 (1.00).The corresponding mean (median) Her"ndahl index of 0.75 (0.89) for the parents is signi"cantlysmaller. About 68% of the spun o! subsidiaries have only one segment.

positive but insigni"cant abnormal returns of 6.51%, 10.58% and 15.18% overholding periods of one, two and three years, respectively. Panel B reports theresults for the focus-increasing parents. The focus-increasing parents earn ab-normal returns of 6.79%, 17.54% and 25.37% for holding periods of one,two and three years, respectively. The three-year abnormal returns are statist-ically signi"cant. The non-focus increasing parents (Panel C) earn abnormalreturns of 5.79%, !6.95% and !10.51% over the same holding periods.Although, the abnormal returns and the corresponding t-statistics are lower forthe parents than those reported for the pro-forma combined "rms (potentiallydue to the removal of the subsidiaries from the combined "rm sample), theirmagnitudes are large in absolute terms. The results suggest that the parents thatincreased their focus exhibit a positive stock market performance followingspino!s.

4.5. Performance of the subsidiaries

Table 7 reports the results for the subsidiaries. The abnormal returns for thefull sample of subsidiaries (Panel A) for holding periods of one, two and threeyears are 15.69% (t-statistic of 2.19), 36.19% (t-statistic of 3.57) and 32.31%(t-statistic of 2.69), respectively. These results show that the subsidiaries exhibita strong positive performance following the spino!s. Panel B reports the resultsfor the focus-increasing sample (subsidiaries of focus-increasing parents). Thesubsidiaries in the focus-increasing sample earn abnormal returns of 22.02%(t-statistic of 2.55), 47.67% (t-statistic of 3.75) and 54.45% (t-statistic of 3.63)over holding periods of one, two and three years, respectively. The correspond-ing abnormal returns for the subsidiaries in the non-focus increasing sample(Panel C) are statistically insigni"cant 0.21%, 8.05% and !21.85%, respec-tively. Compared to the parents, the stock market performance of the subsidia-ries is stronger potentially because the subsidiaries are smaller in size and aremore focused than their corresponding parents.8

The above results show that the positive abnormal performance followingspino!s is due to the focus-increasing spino!s. A similar pattern is also ob-served when the parents and the subsidiaries are analyzed separately, althoughthe statistical signi"cance of the abnormal returns of the subsamples is notalways as strong. Overall, the results indicate that both the parents and thesubsidiaries contribute to the superior performance of the focus-increasingsample.


Table 7Stock market performance of the subsidiaries following spino!s

Raw buy-and-hold returns for the sample "rms (RA=F), raw buy-and-hold return of the bench-mark portfolio (RA=P), the abnormal return (AHAR), the t-statistic associated with the abnormalreturns and the percentage of positive abnormal returns (%#ve) over several periods following themonth of ex-date are reported for the entire sample of 162 subsidiaries as well as the focus-increasingand the non-focus-increasing sub-samples. The focus-increasing sample comprises subsidiaries ofthose parents that either had an increase in sales based Her"ndahl index or an analysis of the annualreports, news items and an examination of the industries of the parents and the subsidiariesindicated that the spino! increased the focus of the "rm. The subsidiaries of the remaining parentsare classi"ed as the non-focus-increasing sample. The benchmark portfolio return is the return toa matching "rm matched on size (market value of equity) and 2-digit SIC code in the month ofex-date. If the "rst matching "rm disappears, then its return is replaced with a second matching "rmalso selected in the month of ex-date. Once all the four matching "rms are exhausted, then we use thereturn of the CRSP equal-weighted index from that point on. If the sample "rm disappears, then theproceeds are assumed to be invested in the benchmark portfolio. EX is the month of the ex-date.Panel A reports the results for all subsidiaries, Panel B reports the results for the subsidiaries offocus-increasing parents and Panel C reports the results for the subsidiaries of non-focus-increasingparents


Panel A: All subsidiaries

EX#1 to EX#12 162 27.07 11.38 15.69 2.19*** 60.5EX#1 to EX#24 162 59.03 22.84 36.19 3.57*** 67.2EX#1 to EX#36 162 71.63 39.32 32.31 2.69*** 56.8

Panel B: Subsidiaries of focus-increasing parents

EX#1 to EX#12 115 29.39 7.37 22.02 2.55*** 61.7EX#1 to EX#24 115 66.65 18.97 47.69 3.75*** 67.8EX#1 to EX#36 115 88.28 33.83 54.45 3.63*** 64.3

Panel C: Subsidiaries of non-focus-increasing parents

EX#1 to EX#12 47 21.40 21.19 0.21 0.02 57.4EX#1 to EX#24 47 40.36 32.32 8.05 0.53 65.9EX#1 to EX#36 47 30.88 52.73 !21.85 !1.29 38.3


5. Operating performance changes around spino4s

In this section, we examine the changes in operating performance followingspino!s. Although our matching procedure and the de"nition of focus is di!er-ent, our results for the change in the average operating performance are similarto those in Daley et al. (1997). In the next section, we link these results to the


9To create the pro-forma measure for the sample "rm, the operating cash #ow returns of theparent and the subsidiary are combined in proportion of the year-end book value of their totalassets. For the benchmark, the operating cash #ow returns of the parent's matching "rm and thesubsidiary's matching "rm are combined using the above weights.

10Note that because we do not require the availability of data for each of the three years (either inthe pre- or in the post-spino! years) for a "rm to be included in the sample, the mean of thethree-year annual performance is not equal to the average of the three annual numbers. Because ofa similar reason, the median annual performance over a three year period could be substantiallydi!erent from the three medians (one for each year), especially when the sample size is small.

stock market results through cross-sectional regressions. We use the ratio ofoperating cash #ow (Compustat data item d13) to total assets (Compustat dataitem d6) as the measure of operating performance. To abstract from theeconomy-wide or the industry-wide e!ects, we focus on the matching-"rmadjusted numbers. For each "rm in the sample, we select one matching "rmwhich has the same four-digit SIC code as the sample "rm and is closest in size(market value of equity) in the month of spino!. Similar to the analysis of thestock market performance, we present the results for the pro-forma combined"rms as well as the results for the parents and the subsidiaries separately.9

We present both the mean and the median year by year results as well as theraw and the matching-"rm-adjusted operating performance results. For con-venience in comparison, we also present the mean and the median annualoperating performance over a three-year period in the pre-spino! as well as thepost-spino! period. To compute the mean (median) annual performance overthree years, we "rst compute the three-year mean (median) performance for each"rm. A "rm is included in the sample so long as it has at least one year'soperating performance data. Then, the three-year mean (median) annual perfor-mance for the sample is the mean (median) over all the "rms in the sample.10

5.1. Performance of the pro-forma combined xrms

Panels A and B of Table 8 present the results of the operating performance ofthe pro-forma combined "rms for the focus-increasing and the non-focus-increasing subsamples, respectively. We note that there is a small but steadydecline in raw operating performance from year !3 to #3 for each sample.This is consistent with the general decline in raw operating performance for theentire Compustat tape over a similar time period as reported by Barber andLyon (1997).

For the focus-increasing sample, the mean (median) annual matching-"rm-adjusted operating performance in the pre-spino! period (year !3 to year !1)is 1.21% (1.45%). However, our main focus is on the post-spino! operatingperformance and the change in operating performance. The mean (median)annual post-spino! performance (year #1 to #3) is 3.86% (3.11%) and is


Table 8Changes in operating cash #ow returns around spino!s for the pro-forma combined "rm

This table reports operating cash #ow returns on total assets for the focus-increasing sample (Panel A)and the non-focus-increasing sample (Panel B) before the spino! and for the pro-forma combined "rmfollowing the spino! from year!3 to year#3 relative to the year of the spino! (ex-date). The focus-increasing sample comprises those "rms that either had an increase in sales based Her"ndahl index oran analysis of the annual reports, news items and an examination of the industries of the parents andthe subsidiaries indicated that the spino! increased the focus of the "rm. The remaining sample isclassi"ed as the non-focus-increasing sample. The operating cash #ow return is de"ned as the ratio ofthe year-end operating cash #ow (Compustat data item 13) to the year-end total assets (data item 6). Inthe post-spino! period, the operating cash #ow returns of the parents and the subsidiaries are com-bined in proportion of their year-end book value of total assets. The industry benchmark is created bycombining the operating cash #ow return of the parent's matching "rm and the subsidiary's matching"rm using the above weights. In the pre-spino! period, the benchmark is created by combining thevalues of the parent's and the subsidiary's matching "rm using the total assets of the parent and thesubsidiary in the year of spino! (year 0). The matching "rms are selected based on size (market value ofequity) and a 4-digit SIC code match in the month of ex-date. The signi"cance of the mean is deter-mined using a t-test and the signi"cance of the median is determined using the Wilcoxon sign-rank test

Year relative to spino! Numberof obs.

Firm Industry adjusted

Mean (%) Median (%) Mean (%) Median (%)

Panel A: Pre- and post-spinow operating cash yow returns for the focus-increasing sample

!3 80 14.69 14.97 1.28 0.09!2 82 14.56 14.57 0.46 1.01!1 84 14.44 13.34 1.52 2.20

Annual performancefrom yr!3 to !1

84 14.75 13.94 1.21 1.45*

#1 75 13.46 13.04 3.83** 3.80**#2 68 13.36 12.97 4.16* 2.31**#3 61 12.51 12.87 1.27 0.31

Annual performancefrom yr#1 to #3

76 13.50 13.62 3.86** 3.11***

Panel B: Pre- and post-spinow operating cash yow returns for the non-focus-increasing sample

!3 27 14.07 14.28 !1.36 !0.29!2 28 14.18 13.51 !0.65 0.10!1 28 15.09 13.51 0.05 0.05

Annual performancefrom yr!3 to !1

28 14.39 13.70 !0.55 0.10

#1 27 11.35 13.32 !0.49 0.47#2 26 11.70 11.73 !0.62 1.38#3 21 12.32 11.69 !0.16 0.68

Annual performancefrom yr#1 to #3

27 11.68 13.97 !0.60 1.80



11We thank the referee for drawing our attention to this point.

statistically signi"cant at the one percent level. Furthermore, the mean changefrom the pre-spino! period to the post-spino! period is 2.95% with a t-statisticof 2.04 indicating that there is a signi"cant improvement in the operatingperformance for the focus-increasing "rms. The results presented are conserva-tive for two reasons. First, instead of three years, if we were to concentrate onone or two years around the year of the spino!, the results are stronger. Second,note that the results are presented with respect to the year of completion of thespino!. However, some of the announcements are made in year !1. If we wereto change the designation of year 0 for those "rms from the ex-year to theannouncement year, the results are stronger.

We also estimate a regression of the post-spino! matching-"rm-adjustedmedian annual operating performance on the corresponding pre-spino! me-dian. This regression is similar to the one presented by Healy et al. (1992) formergers. Healy et al. argue that this speci"cation controls for the continuation ofoperating performance from the pre-spino! period to the post-spino! period.The intercept in this regression represents the improvement in the matching-"rm-adjusted operating performance. We "nd the intercept to be 3.78%(t-statistic of 2.47) which we interpret as an average annual improvement of3.78% in the operating performance of the focus-increasing "rms.

In contrast, the results in panel B for the non-focus-increasing spino!s showthat there is no improvement in the operating performance following spino!s.The mean and the median operating performance is not signi"cant in any of theyears examined.

5.2. Performance of the parents and the subsidiaries

Table 9 reports the results for the parents and the subsidiaries in the post-spino! period. The results show that the focus-increasing parents (Panel A) andtheir corresponding subsidiaries (Panel B) exhibit positive operating cash #owreturns compared to their matching "rms. For the non-focus-increasing sample,while the performance of the parents (Panel C) is similar to their matching "rms,their subsidiaries (Panel D) signi"cantly underperform their matching "rms.This result seems to imply that the non-focus-increasing "rms may be spinningo! underperforming subsidiaries.11 We test for this possibility later in Section 7.

6. Cross-sectional regressions

In this section, we present results from two cross-sectional regressions toprovide direct evidence of the e!ects of change in focus on the stock market


Table 9Operating cash #ow returns of the parents and the subsidiaries following spino!s

This table reports operating cash #ow returns on total assets for the focus-increasing sample as wellas the non-focus-increasing sample of parents and subsidiaries following spino!s. The focus-increas-ing sample comprises those parents that either had an increase in sales based Her"ndah index or ananalysis of the annual reports, news items and an examination of the industries of the parents andthe subsidiaries indicated that the spino! increased the focus of the "rm. The remaining sample isclassi"ed as the non-focus-increasing sample. The operating cash #ow return is de"ned as the ratioof the year-end operating cash #ow (Compustat data item 13) to the year-end total assets (data item6). The industry benchmark is a single matching "rm. The matching "rms are selected based on size(market value of equity) and a 4-digit SIC code match in the month of ex-date. The signi"cance of themean is determined using a t-test and the signi"cance of the median is determined using theWilcoxon sign-rank test

Year relative to spino! Numberof obs.

Firm Industry adjusted

Mean (%) Median (%) Mean (%) Median (%)

Panel A: Focus-increasing parents

#1 81 13.62 13.04 4.18** 2.39*#2 78 13.58 12.79 6.30** 2.64***#3 73 12.64 12.45 2.89 3.09**

Annual performancefrom yr #1 to #3

81 13.49 14.11 4.62** 2.69***

Panel B: Subsidiaries of focus-increasing parents

#1 85 13.29 12.81 4.81* 1.40*#2 78 11.62 12.48 0.90 1.84#3 75 11.42 11.97 0.74 1.05


86 12.12 12.15 1.95 0.71

Panel C: Non-focus-increasing parents

#1 29 11.78 13.32 !0.69 0.51#2 28 11.87 11.73 !0.81 0.22#3 26 11.87 11.69 !0.86 !0.58


29 12.05 13.97 !0.59 1.58

Panel D: Subsidiaries of non-focus-increasing parents

#1 30 6.77 10.94 !7.08* !0.79#2 30 5.08 10.14 !7.97* !0.68#3 27 4.20 8.84 !8.60 !3.84*


30 4.95 10.84 !8.41* !2.12



12Change in focus (CHGHERF) is the change in Her"ndahl index from the year prior to theannouncement to the year of completion of spino! as presented in Table 3. Change in operatingperformance (CHGCF¹A) is the di!erence between the post-spino! median annual matching-"rm-adjusted operating cash #ow return and the corresponding pre-spino! operating cash #ow return(presented in Table 8).

performance as well as the operating performance. In the "rst regression, weshow a direct relationship between announcement period abnormal returns andchange in focus as well as change in operating performance. The results of theregression are as follows.

ARi" a #b CHGHERF

i# c CHGCF¹A

i,

0.033 0.077 0.112

(3.52) (2.24) (1.82)

F-statistic"4.69, Adjusted R2"7.81% and

Number of observations"88.

The left-hand side variable (ARi) is the three-day (day !1 to #1) announce-

ment period abnormal returns for "rm i around the spino! announcement. Themain coe$cient of interest on the right-hand side is the change in focus asmeasured by the change in the Her"ndahl index (CHGHERF

i). For a better

speci"cation, we also include the change in operating performance(CHGCF¹A

i) as a right-hand side variable.12 The inclusion of the change in

operating performance as the second explanatory variable is appropriate as itwould capture sources of improvement in operating performance that areunrelated to change in focus. The t-statistics are presented in the parenthesesunder the estimated coe$cients. The results of this regression show a signi"cantpositive association between an increase in focus and the abnormal returns.Furthermore, the results show that part of the market's positive reaction tospino!s incorporates expectations of improved operating performance follow-ing spino!s.

In the second regression, we test for a direct association between the change infocus and the change in operating performance via the following regression.

CHGCF¹Ai" a # b CHGHERF

i0.005 0.101

(0.31) (1.68)

F-statistic"2.82, Adjusted R2"1.96% and

Number of observations"92.


13Our conclusions are the same when we use the book value of total assets (Compustat data itemd6) as the denominator for computing "nancial leverage.

The results of this regression show that the change in the operating perfor-mance following spino!s is positively related to the change in focus. Overall, theresults of the above cross-sectional regressions provide evidence of direct associ-ation between the change in focus and the stock market performance as well asthe operating performance.

7. Additional analysis of the non-focus-increasing spino4s

In this section, in an attempt to understand their motivations better, weanalyze the sample of non-focus-increasing spino!s in more detail. We examinethree possible motivations, in particular. First, we examine whether the non-focus-increasing spino!s are undertaken in response to a high level of "nancialleverage or "nancial distress. Lang et al. (1995) show that "rms selling theirassets, on average, have a high level of "nancial leverage and are in "nancialdistress. They do not examine a sample of spino!s. Second, we examine whetherthe parents use these spino!s to transfer a disproportionate amount of debt (inrelation to assets) to the subsidiaries. Parrino (1997) provides an example of thismotive in his case study of the controversial spino! undertaken by Marriott in1992. John (1993) presents a theory in which transfer of debt through a spino! isoptimal under certain circumstances. For example, some shareholders anddebtholders of RJR Nabisco in the 1996 annual meeting argued for a spino! ofNabisco (a food company) from RJR (a cigarette company) because the cigarettecompanies are "ghting a number of lawsuits and are facing many legislative andanti-smoking campaigns. Thus, the probability of a bad state occurring for RJRis much higher than that for Nabisco. The assets of the subsidiary can beprotected from legal claims against the parent if the subsidiary is spun o! intime. Third, we examine whether the non-focus-increasing spino!s are under-taken by parents to spin o! underperforming subsidiaries. By spinning o! anunderperforming subsidiary, the reported accounting performance of the parentwill not be adversely a!ected by the performance of the subsidiary. To the extentthat the debt covenants and management compensation plans use accountingmeasures, the parent would bene"t from such a spino!. In addition, by separat-ing the management of the underperforming subsidiary from the management ofthe parent, the parent commits not to subsidize the underperforming subsidiary.Thus, the parents have incentives to spin o! the underperforming subsidiaries.

We de"ne "nancial leverage as the ratio of the book-value of long-term debt(Compustat data items d9#d34) to total assets (market value of equity#book-value of long-term debt).13 For the focus-increasing spino!s, the


level of "nancial leverage, on average, is about the same as that for theirmatching "rms in the pre-spino! period. The mean and the median matching-"rm-adjusted "nancial leverage in the year prior to spino! are !1.90%(t-statistic of !0.68) and !1.75% (z-statistic of !0.03), respectively. Theresults for the non-focus-increasing "rms also show that, on average, their"nancial leverage is similar to that of their matching "rms in the pre-spino!period. The mean and the median matching-"rm-adjusted "nancial leverage inthe year before spino! are 3.86% (t-statistic of 0.83) and 1.61% (z-statistic of0.48), respectively. In the post-spino! period, the "nancial leverage of both thefocus-increasing and the non-focus increasing subgroups are similar to theirmatching "rm "nancial leverage.

Similar to Lang et al. (1995), we also test for the possibility that the "rms in thesample are under "nancial distress by examining their interest coverage ratio.Interest coverage ratio is the ratio of operating cash #ow to interest expense.A "rm with an interest coverage ratio of less than one is assumed to be"nancially distressed. For the focus-increasing and the non-focus-increasing"rms, the mean (median) interest coverage ratios in the year before the an-nouncement are 8.87 (5.20) and 11.23 (4.60), respectively. These ratios suggestthat these "rms were not facing di$culty in meeting interest expenses. Further-more, in the year before the spino!, only two out of 36 (i.e., 5.5% of the sample)non-focus-increasing "rms have an interest coverage ratio of less than one, thecorresponding number for the focus-increasing "rms is eight out of 95 (8.4% ofthe sample). The distribution of the interest coverage ratio across the twosubsamples does not appear to be di!erent. In addition, none of the spino!s inour sample originated from a bankruptcy process or a formal debt restructuringprocess. Overall, we conclude that neither the focus-increasing nor the non-focus-increasing "rms are in "nancial distress prior to the spino!s. This "ndingcan be reconciled by noting that spino!s do not generate any cash for the parent.If the parents were indeed in "nancial distress and needed to raise money to paydown debt, they would have resorted to asset sales which bring in cash.

We analyze whether the parents transfer a disproportionate amount of debtto the subsidiaries by examining the post-spino! leverage of the parents and thesubsidiaries separately. In the post-spino! period, the "nancial leverage of boththe parents and the subsidiaries, on average, is about the same as that of theirmatching "rms. Thus, there is no evidence of a disproportionate transfer of debt(in relation to assets) from the parents to the subsidiaries. We also investigatethis issue further by reading various news items and "nancial statementsavailable to us. We do not observe any discernible pattern of managerial actionsto reduce "nancial leverage or to transfer debt to the subsidiaries. We concludethat, on average, the non-focus-increasing spino!s are not likely to have beenmotivated by a desire to shift debt to the subsidiaries. Isolated cases of transferof debt from parents to subsidiaries, as in the Marriott's case (Parrino, 1997) arenot ruled out. Even in the Marriott's case, there was strong debtholder activism


14 In the "rst annual report after the spino!, many but not all of the newly created subsidiariesprovide the pro-forma "nancial statements of the year of the spino! as well as the year prior to thespino!.

against the management proposal. The Marriott example only shows that suchattempts to transfer debt from the parent to the subsidiary are not likely to becommon. Common debt covenants such as restrictions on dividends, securitypledges or event risk covenants also make it di$cult for many "rms to transferdebt and/or assets in this manner.

Finally, non-focus-increasing spino!s may be undertaken to spin o! poorlyperforming assets. To test for this hypothesis, we examine the operating perfor-mance of the spun o! subsidiaries in the year of the spino! (year 0) as well in theyear prior to the spino! (year !1).14 We "nd that, on average, the non-focus-increasing parents are spinning o! underperforming subsidiaries. In particular,the mean (median) matching-"rm-adjusted operating cash #ow return of thesubsidiaries of the non-focus-increasing "rms are !9.64% (!1.90%) in theyear before the spino! (year !1) and !14.14% (!5.69%) in the year ofthe spino! (year 0). Both the mean and the median values in the year of thespino! are statistically signi"cant. On the other hand, we "nd that the subsidia-ries of the focus-increasing "rms are not performing poorly as the mean (median)matching-"rm-adjusted operating cash #ow return of the subsidiaries of thefocus-increasing "rms is 3.56% (3.00%) in the year before the spino! and 4.48%(1.67%) in the year of the spino!.

Overall, we "nd that the "rms undertaking non-focus-increasing spino!s donot have high "nancial leverage prior to the spino!s. They also do not appear tobe "nancially distressed at the time of the spino! as they seem to be able to meetthe interest payments easily. Also, the parents do not use these spino!s totransfer debt to the subsidiaries. The results show that the "rms are likely toundertake non-focus-increasing spino!s to separate underperforming subsidia-ries from the parents.

8. Conclusions

We present a number of new results related to corporate spino!s. First, weexamine whether an increase in corporate focus is an explanation for theimproved long-run stock market performance following spino!s. We "nd that inthe three-year period following the spino!s, the focus-increasing sample of 111"rms, on average, earn abnormal returns of 33.36% (t-statistic of 3.19), while thecorresponding abnormal returns for the 44 non-focus-increasing "rmsare !14.34% (t-statistic of !0.82). The focus-increasing "rms outperform thenon-focus-increasing "rms by a statistically signi"cant 47.70% in the three-year


period following the spino!s. The results are robust to the use of alternativede"nitions of focus, to the exclusion of takeover "rms from the sample, and tothe use of alternative benchmark portfolios to compute abnormal returns.

Second, we estimate cross-sectional regressions to provide direct evidence ofassociation between an increase in focus and the stock market as well as theoperating performance improvements following spino!s. We "nd that the an-nouncement period abnormal returns are signi"cantly positively associated withthe change in focus and the change in operating performance. Also, the changein operating performance is signi"cantly positively associated with the change infocus.

Finally, we explore potential motivations for undertaking non-focus-increas-ing spino!s. We "nd that the non-focus-increasing spino!s are not undertakento reduce debt, nor are they undertaken in response to "nancial distress. Theyalso are not likely to have been used by the parents to transfer debt to thesubsidiaries. The results show that "rms are likely to undertake these spino!s toseparate underperforming subsidiaries from the parents.

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