Academic journal article Financial Management

Sources of Hidden Value and Risk within Tracking Stock

Academic journal article Financial Management

Sources of Hidden Value and Risk within Tracking Stock

Article excerpt

Tracking stock for a unit of a firm presumably allows the market to value and monitor that unit independently of the rest of the firm. Announcement of the creation of tracking stock elicits an abnormal share price response of 2.17% on average over a two-day period. The share price response at the time of the announcement is more favorable: when the voting rights of the tracking stock are based on a market valuation; when the parent company's debt ratio is relatively low; when the parent's previous stock performance is relatively poor; and when the parent is not engaging in an acquisition. These results are consistent with reduction of agency problems. At the same time, firms that create tracking stock do not experience higher long-term valuations, suggesting that agency problems are not resolved with the creation of tracking stock.

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"...go. corn will unlock the value and potential of our combined Internet assets..." - CEO Michael Eisner on Disney's announcement it would issue a tracking stock

A relatively recent form of financial engineering is tracking stock, which creates a class of common stock whose value is tied to a specific business unit of a corporation. Tracking stock follows on the popularity of carve-outs and spin-offs, seen as successful in creating value. Skeptics suggest that mere financial innovation does not add value. Tracking stock is distinct from carve-outs and spin-offs in that the unit remains completely controlled by the parent, posing special agency and information asymmetry implications. While tracking stock has some characteristics that may be able to reduce asymmetric information and agency costs, and thereby unlock "hidden value," these same characteristics can actually give rise to new types of information asymmetries and agency problems.

We seek to identify agency- and information-related sources of any hidden value that can be released with the creation of tracking stock and to test empirically whether the hidden value is conditioned on these sources. We also test for changes in risk upon issue of tracking stock, and examine whether any shift in risk is conditioned on information- and agency-related sources.

We find that announcement of the creation of tracking stock elicits a favorable market reaction. The market's initial revaluation is more favorable when: 1) the voting rights of the tracking stock are based on a market valuation; 2) the parent company's debt ratio is relatively low; 3) the parent's previous stock performance is relatively poor; and 4) the parent is not undergoing an acquisition. Each of these relationships is consistent with the idea that tracking stock reduces agency problems. We also find that firms issuing tracking stock under-perform comparable firms over a longer time horizon.

I. Background on Tracking Stock

Tracking stock is created when the board of directors proposes and the shareholders approve a new class of stock whose value is linked to a unit of the corporation. Upon shareholder approval, the parent corporation and the tracking unit file separate financial data with the Securities and Exchange Commission. The value of the tracking unit is related to the specific performance of the unit, which can pay dividends to shareholders independent of the parent corporation. If tracking stock represents merely the cash flows of the tracking unit, then the value of the parent corporation should be its value before issue of the tracking stock minus the value of the tracking stock.

While tracking stock has some features that resemble the stock of a spun-off unit, a tracking stock unit is completely controlled by the parent. There is no transfer of ownership of assets or cash flows to tracking stock shareholders. Furthermore, tracking stock is usually voted with parent shares as a single class, with no separate vote on the tracking unit's management. Voting rights of tracking stock differ by company, but generally allow either a fixed vote or variable voting power linked to the relative market valuation of the tracking unit. …

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