Sulfones in enantioselective organocatalysis

Chapter 2 reviews the literature that focuses on the value sources of spinoff wealth effects.

Past studies have proposed different explanations for the spinoff wealth effects. However, empirical evidence for these explanations is either mixed or scanty.

First, recent finance literature has demonstrated that the short run stock market reaction to corporate news is often incomplete or biased, as shown in section 3.3. Some professional investment funds even view post-spinoff firms as investment candidates in order to earn superior portfolio returns (Dennis, 2006). However, the empirical evidence of the superior returns to post-spinoff firms is questioned by Fama (1998) due to the methodological concern. Section 3.6 further examines the extant evidence of the long-run spinoff stock performance and finds that past studies have not used robust return methodology in estimating the abnormal stock returns to post-spinoff firms. Thus, whether the stock market is efficiently valuing a corporate spinoff is still unclear.

Market inefficiency may occur because investors react to corporate events for non-fundamental factors. A notable example is that investors may over-extrapolate the past performance of event firms to assess the value implications of the event (e.g. see Rau and Vermaelen, 1998; Rosen, 2006). Corporate spinoffs are joint events combining both focus-increasing divestitures and equity offerings of a subsidiary. Therefore, the market reaction to spinoff announcements may be affected by investors’ unrealistic demand for glamour stocks when the offspring’s industry is hot sector (e.g. see Montier, 2002, Chapter 7). However, there is no empirical test on the relationship between investor sentiment and spinoff value gains. Thus, it is unknown whether investor sentiment affects the spinoff value gains.

Theories derived from the governance-based model argue that corporate spinoffs enhance firm performance by improving corporate governance and mitigating agency problems.

For example, Allen et al. (1995) find that spinoff announcement gains are negatively associated with the value losses from the prior diversifying acquisitions. Given that diversifying acquisitions are often due to agency problems (e.g. Amihud and Lev, 1981), the evidence of Allen et al. (1995) indicates spinoff gains stem from the reduction of the agency conflicts of diversification.

However, the value benefits of efficiency improvement in post-spinoff firms may not be realised when the corporate governance in post-spinoff firms is weak and the agency conflicts remain severe. As discussed in sections 2.3.1 and 2.3.3, empirical studies have not directly examined the relationship between corporate governance and spinoff value gains. Therefore, it is not clear whether the governance-based model can explain the spinoff value gains.

Hypotheses derived from the information-based model contend that corporate spinoffs improve firm valuation by alleviating information asymmetry problems. Theoretical models by Habib, Johnsen and Naik (1997) and Nanda and Narayanan (1999) propose that spinoffs expand the financial disclosures and increase the informativeness of the

stock prices, thus improving the investors’ understanding of post-spinoff firms.

Krishnaswami and Subramaniam (1999) further present evidence that spinoff value gains arise from the reduction of information asymmetry following the spinoffs.

Empirical evidence on the information asymmetry hypothesis is also mixed.

Krishnaswami and Subramaniam (1999) use financial analyst forecast data to derive several information asymmetry proxies such as analyst forecast errors and the dispersion of analyst forecasts. They find that these information asymmetry proxies improve following spinoffs and the level of information problems for pre-spinoff firms is positively associated with the announcement returns to spinoff firms. However, Veld and Veld-Merkoulova (2005) use similar information asymmetry proxies but find an insignificant association between information asymmetry proxies and spinoff announcement returns.

There are two theories that predict no information transparency benefits from spinoffs.

Thomas (2002) proposes an information diversification hypothesis that diversified firms may have less information asymmetry problems than focused firms because analyst forecast errors for different divisions of a diversified firm can be offsetting and the aggregated earning forecast for a diversified firm is thus more accurate than that for a focused firm. Goldman (2005) argues that a spinoff may reduce the liquidity of stocks of post-spinoff firms and hence the market’s incentive to collect information is reduced, thus resulting in an increase of information asymmetry of post-spinoff firms.

Given mixed evidence on the information asymmetry hypothesis, it is possible that the information asymmetry hypothesis may only hold for a sub-sample of spinoff parent firms. Past empirical tests on the information asymmetry hypothesis examine the cross-sectional changes of information asymmetry problems, which may not be able to provide a powerful test on the information asymmetry hypothesis. Thus, it remains ambiguous whether the information asymmetry hypothesis can explain the spinoff value gains.

To sum up, the extant literature has not fully explained the sources of spinoff

announcement gains and the evidence on market efficiency in valuing spinoffs is mixed.

This thesis aims to fill the literature gap by empirically investigating the short-run and the long-run market reaction to spinoff announcement. Specifically, two research questions are addressed in this thesis:

1. Do corporate spinoffs really create shareholder value?

2. What are the determinants of spinoff value effects?

In the following section, I set out the possible explanations based on the literature reviews to answer these two research questions.