The long-term performance of parent and units following equity carve-outs

Recent research has shown that ownership restructuring decisions by firms can enhance value. In particular, Allen and McConnell (1998) find that carve-outs elicit a favourable share price response for parent firms at the time the carve-outs are reported. One explanation is that a carve-out facilitates parental focus and enables the market to value a new entity that now has its own identity, which uncovers hidden value. Since these valuation effects are measured when the carve-outs are reported, they reflect an ex ante view of potential change in performance attributed to the restructuring of ownership. An attempt is made to determine the long-term performance of firms following carve-outs. At the time of the carve-out, parents have information about the unit unknown to the public. The performance of parents and the carved-out units are separately assessed to determine whether there is a wealth transfer between the two entities as the asymmetric information that exists at the time of the carve-out dissipates over time. In general, the long-term effects of the parent and the unit following carve-outs are unfavourable. This result is surprising in light of theory behind the potential benefits of carve-outs, and the favourable short-term valuation effects, but not inconsistent with Ritter's (1991) findings regarding the long-run performance of initial public offerings (IPOs). A closer look reveals that the long-term performance is more unfavourable for parents that were distressed before the carve-outs, and more unfavourable for units that were carved out of distressed parents. This suggests that distressed parents may not necessarily resolve their distress with carve-outs, and that the carved-out units of these parents may contain a portion of the distress symptoms.