CEO Gains from Spin-Offs

Sah, Rakesh, Carroll, Carolyn, Review of Business Research

ABSTRACT

Research on spin-offs has focused on the gains to stockholders at the announcement of a spin-off, and the probable reasons for these gains. The Corporate Chief Executive Officer (CEO) is credited for being involved in expansionary acquisition activity for personal gains rather than for stockholder wealth maximization. Then why do CEO's propose and plan to downsize their empire through a spin-off? This paper examines the CEO incentives to downsize through voluntary corporate spin-offs. It shows that the interests of the CEO of a firm and its stockholders do not always diverge and a gain for the latter also profits the former.

Keywords: Corporate Restructuring, Divestments, Managerial Compensation, Spin-offs.

1. INTRODUCTION

Divestments boost shareholder wealth relatively painlessly and without adverse publicity, as is the case with, say, downsizing through layoffs. Spin-offs score over other forms of divestments (for example sell-off, carve out etc.) in that they are usually tax-free, do not involve external financing and pass the gains directly to the shareholders.

Financial literature has suggested that managerial hubris plays a significant role in corporate governance, and managerial decision-making is not undertaken with the sole interest of the stockholders (Jensen and Meckling 1976). Corporate managers are credited for being involved in expansionary merger and acquisition activity for personal gains rather than for the maximization of shareholder wealth (Roll 1986). Therefore, that Chief Executive Officers (CEO's) willingly propose, and plan, to downsize a firm through divestments seems, at first, to go against conventional literature.

The purpose of this paper is to examine the CEO incentives to divest corporate assets through voluntary spin-offs. It will establish that the interests of shareholders do not completely diverge with those of the CEO's, and that the latter also stand to gain in a spin-off. The gains or losses to CEO's can be either non-pecuniary or pecuniary. The Chief Executive Officer (CEO) for one will not experience any satisfaction from witnessing the corporate empire being cut down in size. A smaller company may imply, among others, a relatively smaller budget, fewer employees, a smaller geographical area of operation, and fewer corporate resources. All these are indicative of non-pecuniary losses. Pecuniary gains in the form of higher monetary compensation are more uniformly applicable to all managers. The total compensation package of a corporate executive would comprise not only salary and bonus, but also stock-based options and benefits. CEO gains would also include increments in managerial wealth due to increases in the value of managerial stock and stock options, all of which have been earned in the past. This paper will establish that gains in the form of higher compensation packages and increases in the value of CEO portfolio of insider stock are the incentives that would push an otherwise recalcitrant CEO to spin-off. Therefore, even though CEO's stand to lose some non-pecuniary benefits, gains in CEO welfare due to an increase in the present value of their future earnings and in the value of their stock of wealth will be ample incentives to encourage spin-offs.

The literature on managerial compensation indicates the strong relationship between stock performances and compensation. To motivate managers to this end strong incentives are placed in the overall compensation packages. The literature on spin-offs indicates the positive stock reaction to voluntary spin-offs. Are the ensuing compensation and wealth gains also a reason that CEO's spin-off? This question is the prime focus of the paper

2. METHODOLOGY

Hypothesis 1

Prior research has used samples drawn primarily from the 1980's and earlier. This study uses a more recent sample from 1980 to 1996; further, the sample requirements for this study are more restrictive than in the earlier ones. Therefore, the first hypothesis tests the conformity of our data set with those in the earlier studies.

[H.sub.01:] The gains to the shareholders of spin-off firms …

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Publication information: Article title: CEO Gains from Spin-Offs. Contributors: Sah, Rakesh - Author, Carroll, Carolyn - Author. Journal title: Review of Business Research. Volume: 7. Issue: 1 Publication date: January 2007. Page number: 178+. © 2008 International Academy of Business and Economics. COPYRIGHT 2007 Gale Group.

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