WEALTH EFFECT OF SPIN-OFFS IN SINGAPORE : AN INVESTIGATION ON SHAREHOLDERS' VALUE GAIN IN PARENT AND SPUN-OFF FIRM FROM WEALTH RE-ARRANGEMENT EFFECT

Abstract

This study investigates whether shareholders' value in (a) parent and (b) spun-off firms increases from the spin-off of a subsidiary in Singapore during 1975 to 1996. Galai and Masulis (1976) conceptualised that transfer of assets from the parent to spun-off firm (where the parent shareholders obtain proportionate stake) reduces the parent debtholders' collateral, which increases the debt default risk resulting in the shareholders' value gain at the cost of debtholders. Hence, the combined value of both parent and spin-off stocks should become larger. A few empirical studies found that stockholders' wealth increase from spin-off announcement in the U.S. These studies did not investigate the spin-off wealth effect, particularly combined shareholders' value increase from spin-off as suggested by the wealth re-arrangement/redistribution hypothesis: see Milles and Rosenfeld (1983), Hite and Owers (1983), Seifert and Rubin (1989), Vijh (1994) and Johnson, Klein, and Thibodeaux (1996). No evidence;: on this effect is available in a non-U.S market Hence, the present study of Singapore spin-offs is expected to provide new evidence of shareholders' wealth increase from spin-offs in a fast developing Asia-Pacific capital market. The strategic hypothesis is that the aggregate stock value of parent and spin-off firms together is greater than the parent stock value alone if subsidiary had not been spun-off. Other five subsidiary hypotheses are also formulated. Of which, three are about the parent stocks' performance around the spin-off announcement, ex-date, and listing time. The other two are about the initial and aftermarket performance of spin-off stocks. The parent and spin-off stocks are expected to perform abnormally because of wealth effect and certification effect. In aftermarket, however, the spin-off stocks' prices are expected to-be corrected downward. The study applied the standard event study method to investigate abnormal performance over event periods. It is found that parent stockholders earned 3.08% abnormal return on spin-off announcement month with a 8.93% cumulative abnormal return over a seven-month period (-6 to 0 months) providing evidence of wealth effect of spin-off announcement on the parent firms. In the post-announcement period, the shareholders lost 2.4% cumulative abnormal return due to post-announcement uncertainty about successful implementation of spin-off. However, the lost-value is re-captured when uncertainty is resolved on the ex-date, and the portfolio of parent stocks earned 2.57% abnormal return. On spin-off listing month, parent portfolio also earned 2.73% abnormal return. However, the parent portfolio loses 4.3% cumulative abnormal return once spin-off stocks become listed. The parent stockholders earned 9.11% net cumulative abnormal return over a period starting from 10 months before announcement through to 10 months after spin-off listing. The spin-off stocks earned a significantly large positive initial excess return of 37.12% on first trading day, suggesting the spin-off stockholders' value increased due to spin-off effect as the wealth re-arrangement and certification effects. This excess return may be partially due to market overreaction as welt Therefore, in the aftermarket, the spin-off stock prices are found to have moved downward losing up to 9.17% of the 37.12% cumulative excess return on spun-off value over 10 months. Above all, shareholders (who are also the shareholders of parent companies) therefore gain a net 27.95% initial excess return in spin-off stock value form, which is about 6.62% of the parent equity value. Thus, the combined cumulative abnormal performance of both parent and spin-off stocks in parent stock value form is 15.73% over observation period. 'The evidence is generally consistent with the spin-off value effect suggested in wealth rearrangement/re-distribution hypothesis that is parent-cum-spun-off stockholders' combined value becomes larger after separation of subsidiary. A test of correlation between parent's debt-asset ratio and observation period's abnormal performance showed that the parent's and parent-cum-spun-off's abnormal performance are significantly and positively correlated with the parent's debt-asset ratio. Therefore, it can be concluded that stockholders' value gain from the spin-off decision is due to wealth re-arrangement effect given the analysis of Galai and Masulis. Part of the value increase spin-off stocks is expected to be due to certification effect of spin-off stock listing. A direct test on bond returns, however, could not be done.