J Manag Gov (2014) 18:471–503
DOI 10.1007/s10997-012-9245-2
Corporate governance and market performance
of parent firms following equity carve-out
announcements
Salim Chahine • Mohamad Jamal Zeidan
Published online: 21 October 2012
Ó Springer Science+Business Media New York 2012
Abstract Using the Gompers, Ishii, and Metrick corporate governance index on a
sample of 158 parent firms, this study demonstrates that firms with a superior governance rating have a higher short-term market reaction to carve-out announcements
relative to firms with an inferior governance rating. Although the data supports previous evidence regarding negative long-term market reaction that parent firms typically experience following equity carve-outs, the results show that well-governed
firms marginally outperform others. The findings also confirm that the dynamic
effects related to improvements in corporate governance positively affect the longterm market outcome of parent firms; this relation is more significant in well-governed parent firms. Finally, the study shows evidence that corporate governance helps
mitigate the agency problems related to the financing hypothesis, which results in
better short and long-term market reactions following carve-out announcements.
Keywords
Equity carve-outs Market reaction Corporate governance
JEL Classification
G24 G32 G34
1 Introduction
An equity carve-out is the partial sale by a parent company of a subsidiary through
an initial public offering (IPO). Typically, the parent company would still hold a
S. Chahine (&)
Department of Finance, The Olayan School of Business, American University of Beirut, Bliss Street,
Beirut, Lebanon
e-mail: [email protected]; [email protected]
M. J. Zeidan
Department of Management, The Olayan School of Business, American University of Beirut,
Bliss Street, Beirut, Lebanon
e-mail: [email protected]
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significant share in the subsidiary but may potentially lose management control
following the equity carve-out.
Prior research illustrates positive short-term abnormal returns for parent firms
post equity carve-out announcements (Nanda 1991; Allen and McConnell 1998).
Following equity carve-outs, parent firms benefit from increased operational
efficiency (Hulburt et al. 2002; Aron 1991; Meyer et al. 1992; Schipper and Smith
1986). This is consistent with the hypothesis of divestiture gains, namely that the
sale of equity generates cash that the parent firm can put to more efficient use
(Hulburt et al. 2002; Vijh 2002; Hite et al. 1987; Schipper and Smith 1986). The
positive market reaction to carve-out announcements may also relate to the
financing asset sales hypothesis (Lang et al. 1995) and subsequent managerial
discretion hypothesis. Allen and McConnell (1998) state that management values
control and firm size, and thus firms will engage in sales of assets (such as equity
carve-outs) only when they represent the least expensive method of generating
needed funds. Since firms engaging in equity carve-outs generally have high
leverage and poor operating performance, when funds generated through equity
carve-outs are used to pay off debt or are distributed to shareholders the average
excess stock return is significantly greater than when funds are retained for
investment purposes (Lang et al. 1995; Allen and McConnell 1998).
Further, the increase in short-term abnormal returns may be explained by the
asymmetric information hypothesis (Myers and Majluf 1984; Nanda 1991), which
implies that management of undervalued firms use equity carve-out announcements
to signal their actual higher value to investors (Nanda 1991) and to generate cash
from potentially overvalued subsidiaries (Powers 2003; Slovin et al. 1995). This
cash can then be used to invest in other positive NPV subsidiary projects that the
firm might otherwise have rejected (Nanda 1991).
However, equity carve-outs may negatively affect the long-term returns of parent
firms (Chemmanur and Paeglis 2001; Michaely and Shaw 1995; Madura and Nixon
2002). This discrepancy may be partly due to the fact that carve-outs can be motivated
by financial reasons rather than the search for operational efficiency (Madura and
Nixon 2002; Lang et al. 1995; Allen and McConnell 1998), or due to the use of market
timing by self-interested managers (He et al. 2009). The major consequence would be
the creation of a conflict of interest between managers, shareholders, and other
stakeholders. As a corporate restructuring mechanism, an equity carve-out affects
governance attributes by reducing agency problems related to empire building (Lang
et al. 1995), by strengthening the accountability of subsidiaries’ managers (He et al.
2009), and through the requirement of audited financial statements for the subsidiary.
Surprisingly, despite recent corporate scandals, scant research is available that
examines the association linking the effects of corporate governance and the stock
market reaction to parent firms in the period pursuing carve-out announcements. This
paper fills this gap in literature by examining the differential role played by corporate
governance and its effect on short-term and long-term market reaction following
equity carve-out announcements by parent firms.
Based on the agency theory rationale, corporate governance should affect market
reaction positively for the period surrounding equity carve-out announcements by
mitigating the problems caused by the separation of ownership and control.
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However, as corporate governance is a dynamic process that changes over time, the
long-run stock market reaction depends on both the initial level of corporate
governance at the time of the carve-out as well as on the following changes in
corporate governance practices. Improvements in corporate governance practices
should hence amplify the pricing of parent firms and help produce superior longterm market performance, ceteris paribus.
Using an exhaustive sample of 158 parent firms that completed carve-outs between
the years 1990 and 2006, and which had an identifiable Gompers et al. (2003)
governance index (G-Index), the results show that corporate governance significantly
affects both short-term market reaction around carve-out announcement and long-run
market performance following the announcement date. More specifically, bettergoverned firms exhibit significantly higher abnormal returns than firms with lower
governance around the announcement date. While the results for the entire sample
show no significant gain in the long run, well-governed firms do benefit from positive
abnormal returns. Furthermore, firms that manage to improve their governance over a
3 year period achieve a higher market reaction, implying that post carve-out market
performance is positively correlated with improvements in corporate governance. The
results also show that firms that start with good governance and improve their rating
over time continue to increase their performance, all other variables being equal. In
further investigations, we control for the use of proceeds and we show evidence of the
positive effect of corporate governance on the association between market reaction
around carve-out announcements and the payout-related use of proceeds. Hence,
well-governed parent firms have a higher 1-year buy-and-hold return when they use
their proceeds for payout purposes. Further robustness checks using the Bebchuk et al.
(2009) entrenchment index confirm our results.
The main contribution of this paper is threefold. First, using a sizeable sample,
this study shows empirical evidence of the effects of corporate governance
mechanisms on short-term and long-term market reactions of parent firms’ stock
price to equity carve-out announcements. As such, the findings complement prior
research on the association between corporate governance and corporate restructuring strategies (D’Souza et al. 2001; He et al. 2009).
Second, the paper illustrates the dynamic association between long-run stock
market reaction and corporate governance changes. Consequently, this study
contributes to a line of research addressed by few papers that stresses corporate
governance as a potentially active dynamic process evolving over time. Specifically,
the empirical findings indicate that firms might benefit from continuous improvements in their G-Index. Interestingly, the results show that long-run stock market
reaction is higher in parent firms with higher corporate governance, especially those
able to further improve their governance standards. One explanation is that investors
account for the differences in corporate governance between well and poorlygoverned firms. On the other hand, this finding suggests the existence of differences
in the learning curve of firms in dealing with their governance standards (Huse
2005; Lane 2003). As such, well-governed firms are more likely to benefit from
improvements in their intangible ‘‘know-how’’ (i.e., corporate governance) to
support their market performance relative to poorly governed firms.
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Third, the results indicate that corporate governance mitigates the agency
problems related to managerial discretion that arise in parent firms using funds to
repay credit and/or shareholders. Corporate governance hence ensures the adequate
monitoring conditions required for managers to choose an optimal balance between
debt and equity capital that result in a higher stock market reaction following carveout announcements.
The paper is organized as follows: the next section provides a literature review of
carve-outs and presents the corresponding hypotheses related to short-term and long
term market reactions, improvements in corporate governance, and the use of
proceeds from carve-outs. Section three presents the data and methodology used in
the empirical study. Section four describes the empirical results and discusses them.
Section five presents further investigations and robustness checks. Finally, section
sixth is devoted to the main conclusions as well as suggestions for further research.
2 Review of literature and hypotheses
2.1 Short-term market reaction and corporate governance
An equity carve-out is a corporate restructuring event that has several potential
motives. Managers may use carve-outs as a signal (Myers and Majluf 1984) when
they think that the parent company is under-valued and the subsidiary is overvalued, following the asymmetric information hypothesis (Nanda 1991). Carve-outs
may also reduce information opaqueness when investors, not knowing the real value
of the combined firm prior to a carve-out, react conservatively and undervalue the
equity (Elsas and Loffler 2001). However recent research has found more support
for the hypothesis of divestiture gains, which indicates that equity carve-outs may
improve efficiency and managerial incentive contracts (Aron 1991; Meyer et al.
1992; Hulburt et al. 2002), and reduce negative synergies between parents and
subsidiaries especially when strategic incompatibilities exist in their businesses
(Schipper and Smith 1986; Vijh 2002). Managers may also resort to carve-outs
when they believe that the future performance of their subsidiaries is higher than
their estimated market valuation (Baker and Wurgler 2002; Powers 2003). Several
other miscellaneous reasons such as tax reduction, regulatory compliance, and
takeover defense may motivate companies to execute carve-outs (Vijh 2002).
Furthermore, equity carve-outs may be related to a financing motive such as fundraising (Vijh 2002; Powers 2003; Frank and Harden 2001), where parent firms use
the raised funds to pay the parent or subsidiary debt or to service other cash flow
needs (Allen and McConnell 1998; Lang et al. 1995), or to finance new positive
NPV investments (McConnell and Muscarella 1985; Schipper and Smith 1986).
Therefore, investors are likely to perceive an equity carve-out as a profitable
divestiture strategy, thus leading to a positive stock price reaction. Previous research
documents an average abnormal return close to 2 % around an equity carve-out
announcement (Allen and McConnell 1998; Nanda 1991; Schipper and Smith 1986).
Equity carve-outs may however induce potential conflicts of interest between
managers and shareholders, identified by Allen and McConnell (1998) as the
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managerial discretion hypothesis Indeed, the former may sell assets when the sale
presents the cheapest way to obtain funds that can be used to pursue their own
objectives rather than maximizing value (Lang et al. 1995). Given that managers
usually value size and control, increasing efficiency may not be the only motivation
for selling assets. If managers want to pursue their own interests, asset sales gives
them more discretion on spending funds and thus presents a better alternative than
other sources of financing like debt that are usually more restrictive. Therefore, the
surplus funds that result from the partial IPO may cause extra agency costs. For
example, instead of investing in positive NPV projects that increase shareholders’
wealth, the surplus funds can be used to finance operating losses, or simply may not
be in the long-run best interest of shareholders (Allen and McConnell 1998). Allen
and McConnell (1998) also found that firms pursuing carve-outs generally have high
leverage and poor operating performance, placing them in a riskier financial
position. It should be noted, however, that leverage and the relative riskiness of a
firm do not necessarily indicate the presence of agency costs. A study on takeover
financing by Martynova and Renneboog (2009) touched on this issue, as it
considered conflict of interest between management and shareholders as a potential
factor in such financing decisions and found that agency problems do not play a
significant role. They found that riskier firms do not have a standard preference for
financing their takeovers with equity, even when debt financing is less attractive.
Thus it is important to study the level of control that managers exert in the firm in
addition to the firm’s financial structure.
Management entrenchment and the existence of anti-takeover devices have been
found to increase the likelihood of shareholder-initiated proxy proposals, particularly targeted towards firms which are both underperforming and which have poor
governance structures (Renneboog and Szilagyi 2011). The results showed that the
economic effects of entrenchment were robust compared to the broader G-Index,
which includes anti-takeover devices. Renneboog and Szilagyi (2011) found that the
marginal benefits of increased shareholder control are highest when there is a
market premium on good governance, a finding that could be applicable in the case
of asymmetric information surrounding equity carve-out announcements.
In light of recent corporate scandals, effective control mechanisms that ensure
funds are not wasted nor expropriated by managers affect investors’ reaction to
carve-out announcements. Investors may be willing to pay a premium for firms with
good corporate governance as that may increase trust (Bauer et al. 2004) and lead to
more efficient operations such as higher expected cash flows (Bauer et al. 2004).
Corporate governance has a favorable effect on firm valuation in general, and
should naturally have a positive impact on the gains resulting from carve-outs by
alleviating some of the agency costs post carve-out. In addition, corporate
governance reduces the risks of asymmetric information signaling and limits
managerial discretion, which could be perceived to increase the likelihood of
divestiture gains. Hence, corporate governance should positively affect market
reaction around carve-out announcements.
H1: Short-term market reaction around carve-out announcement is positively
related to corporate governance practices of parent-firms.
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2.2 Long run market reaction and corporate governance
While most studies agree that short-term market reaction to equity carve-outs is
generally positive, evidence exists of an insignificant or negative long-run performance of carve-out parents (Chemmanur and Paeglis 2001; Michaely and Shaw 1995;
Vijh 1999). While the initial positive response results from market expectations, the
long-term revaluation reflects market realizations (Agrawal et al. 1992). Madura and
Nixon (2002) examine the long-term performance of parent firms and units following
equity carve-outs. They find that a carve-out has a negative effect over time if the
parent does not reap the benefits of the narrow focus. In fact, equity carve-outs provide
a compromise between minimizing the costs of full integration while still maintaining
the benefits associated with ownership and control rights. Parent firms may choose to
maintain operational and managerial control in the carved-out subsidiaries. The
potential for ongoing parental involvement via both ownership and overlapping
executives and directors counteracts the separation and independence between the
parents and the carved-out subsidiaries, which may affect the performance of parent
firms adversely (Boone et al. 2003). The major implications are that parent firms
would not reap the full benefits of the improved focus in the long run and that tight
control by the parent might lead to additional agency costs. This issue suggests that
corporate governance can play a role in improving the long term stock market reaction
of firms post- carve-out by limiting managerial discretion in situations where
managers take the decision for reasons beyond improving efficiency and achieving
divestiture gains, and by allowing for more oversight of the actual uses to which the
raised capital is put in the long term. More significantly, corporate governance must
play a role in the decision itself; that is improving efficiency should be the primary
motivation for resorting to the carve-out in well-governed firms (Powers 2003).
Corporate governance may thus mitigate the conflict of interest between shareholders
and managers following carve-out events, which results in a higher stock market
reaction for firms with good governance.
H2: Long-run market performance following carve-out announcement is positively related to corporate governance practices of parent firms.
2.3 Improvements in corporate governance and long run market reaction
Corporate governance practices are however dynamic variables that change over
time. For this reason, corporate governance changes as a result of a learning process
taking place at various levels: societal, organizational, group, and individual.
Changing awareness, concepts, and rules at any of these levels may lead to changes in
corporate governance (Huse 2005). Corporate governance rules are the result of the
shared mental models of the various stakeholders. As mental models evolve through
the learning process, so does corporate governance (Pochet 2005). Sundaramurthy
and Lewis (2003) provide a framework for corporate governance based on both
control and collaborative approaches. The two perspectives get fostered in an
organization via a learning process consisting of various re-enforcement and selfcorrecting cycles.
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However, each firm perceives the learning process in corporate governance
differently. When studying the evolution of corporate governance in German firms,
Lane (2003) finds out that listed firms outperform unlisted and family controlled
firms in improving their corporate governance standards. This finding supports the
idea that firms have different learning curves in the case of corporate governance.
As such, corporate governance practices reflect both the learning processes and the
learning curves of parent firms. Consequently, the long-term market reaction of
parent firms would depend on both the initial level of corporate governance as well
as changes in corporate governance practices following their carve-outs. Accordingly, we expect the market reaction of parent firms following carve-out
announcement to be positively related to the interaction between corporate
governance practices and their improvement in the long run. Hence:
H3: Parent firms with improving corporate governance practices in the long run
have a higher association between corporate governance practices and market
reaction following carve-out announcement.
3 Data and methodology
3.1 Sample data
The sample is extracted from the total list of 609 carve-outs identified in the SDC
platinum database from 1990 to 2006. Since the ultimate goal is to examine the
effect of corporate governance practices of parent firms on their market reaction, the
data excludes carve-outs of trusts, holdings, Units, REITs, foreign and non-listed
parent firms. This filtering process results in 440 carve-outs by US listed parent
firms. Also, all companies that are spin-offs or that announced a planned spin-off
following carve-outs have been excluded (i.e., two-stage carve-outs), which results
in 316 pure carve-outs (see Low (2001), Thompson and Apilado (2006), and
Chahine and Goergen (2010) for a discussion of the difference between spin-offs,
pure carve-outs, and two-stage carve-outs). Empirical investigations focus on parent
firms for which we were able to identify their corporate G-Index from the Gompers,
Ishii and Metrick Index database,1 and the announcement dates of their carve-outs
(through Factiva database). Gompers et al. (2003) develop a corporate G-Index for a
large number of listed firms in the US markets for the following years: 1990, 1993,
1995, 1998, 2000, 2002, 2004, and 2006. In line with Gompers et al. (2003),
empirical results use the Corporate G-Index of the previous year for a parent firm
with an equity carve-out occurring during a missing year (e.g. the index of 2000 for
a carve-out in 2001). The final sample thus includes 158 carve-outs. Selected parent
firms have a wide market capitalization ranging between $29.95 million and
$465,628 million, with an average capitalization of $11,705 million. They also have
varying degrees of corporate governance based on G-Index of Gompers, Ishii and
Metrick database, ranging from 2 to 15, with an average of 9.426. Firm level
1
We are thankful to Professor Metrick who gives access to the Governance Index Data by Firm,
1990–2006 on his webpage (http://faculty.som.yale.edu/andrewmetrick/data.html).
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characteristics were obtained from Thomson One Banker database, and stock prices
were collected from the Center for Research in Securities Prices (CRSP).
Table 1 compares the sample to the entire population of pure carve-outs. The
table shows that the sample has a distribution of IPOs per year and per industry that
is close to the population. Also, the average market capitalization of the sample
firms is slightly but not significantly higher than that of the population. Hence,
Table 1 indicates that the sample is representative of the population of pure carveouts.
3.2 Methodology
In order to assess market reaction to carve-outs, both buy-and-hold abnormal returns
(BHAR) and cumulative abnormal return (CAR) measures are used. Abnormal
returns are the difference between the actual return of studied firms and the rate of
return of a matched sample of firms.2
The propensity scores matching approach identifies a control sample of listed
firms without significant differences in its characteristics compared to our studied
sample. Recent research shows that this technique produces accurate estimates from
the population of the potential matching subjects. The propensity scores technique
controls for endogeneity related to the selection bias on observed firm characteristics (Dehejia and Wahba 2002). Using the propensity-score logit calculated based
on a set of selected firms’ characteristics, we measure the probability for a company
to have a carve-out firm. Following previous studies, we use a set of factors in the
propensity score-matching algorithm, which includes same industry dummy, FreeCash Flow to Total Assets, Parent ROA, Price-to-Book Ratio, and Dividend Yield
(these variables are explained later in the control variables section). With the
estimated propensity score values, we matched each parent firm with a carve-out to
a single public company with the closest score value within the same industry. In
line with prior research, the industry restriction reduces differences in operating risk
characteristics between the sample firms and their comparable firms, and allows us
to obtain economically meaningful matches.3 For short term reaction, BHAR -1/1,
-3/3, and -5/5 days, which are the BHAR over a 3-, 7-, and 11-day period around
the announcement day of carve-out, are used. BHAR is the compounded return on a
sample firm less the compounded return on a reference portfolio (Barber and Lyon
1997). BHAR measures the difference between a strategy of investing in firms that
completed an event then selling at the end of the holding period, and a similar
strategy applied to control or non-event firms (Mitchell and Stafford 2000). Also,
CAR -1/1, -3/3, and -5/5 days are used; these are the cumulative, that is, the sum
of daily, abnormal return over a 3-, 7-, and 11-day period around the announcement
day of carve-out.
2
Li and Zhao (2006) show that the propensity score approach yields higher results than the traditional
matching approach.
3
In a former version of the paper, we used comparable firms that have a market capitalization within the
±25 % range of the market capitalization of the sample firm and are within the four-, three-, or even twodigit SIC code. The results are qualitatively similar and they remain available upon request.
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Table 1 Sample representativeness
Years
Sample parents with carve-outs
(N = 158)
Entire population of parents with carve-outs
(N = 316)
N
N
%
%
1990
5
3.16
8
1991
15
9.49
30
9.49
1992
14
8.86
46
14.56
1993
21
13.29
61
19.30
1994
17
10.76
38
12.03
1995
9
5.70
17
5.38
1996
15
9.49
33
10.44
1997
7
4.43
17
5.38
1998
6
3.80
11
3.48
1999
13
8.23
16
5.06
2000
11
6.96
11
3.48
2001
10
6.33
10
3.16
2002
7
4.43
7
2.22
2003
2
1.27
2
0.63
2004
1
0.63
4
1.27
2005
2
1.27
2
0.63
2006
3
1.90
3
0.95
Industry classification
2.53
Sample
Population
No.
%
No.
%
SIC1
8
5.06
10
SIC2
19
12.03
30
9.49
SIC3
31
19.62
68
21.52
SIC4
30
18.99
34
10.76
SIC5
22
13.92
34
10.76
SIC6
29
18.35
87
27.53
SIC7
14
8.86
34
10.76
SIC8
5
3.16
19
6.01
Market capitalization (in $mil)
Mean
SD
Median
11,526
2,617
39,121
3.16
Mean
SD
Median
T difference
7,657
986
0.280
32,083
This table compares the distribution across time, industries (1 digit SIC Code), and market capitalization
of the carve-outs in the sample to that of the entire carve-outs population from 1990 to 2006. Market
capitalization was collected from CRSP database
For long-term reaction BHAR 1Y, BHAR 2Y, BHAR 3Y representing BHARs
for 1, 2, and 3 years are used. Prior research indicates that the BHAR method is
preferred over CAR because the CAR method suffers from several biases.
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Moreover, BHAR accounts for investors’ experience (Barber and Lyon 1997).
BHAR has become widely used to measure long-term stock market reaction in
recent years (Mitchell and Stafford 2000).
To examine the effect of corporate governance on short-term and long-term
market reaction, the Gompers, Ishii and Metrick G-Index (2003) is used. This index
is a corporate governance rating scale that measures quantitatively the level of
protection of shareholders’ rights of a firm. The index is based on 24 protection
provisions. A firm’s score is the sum of provisions that restrict shareholders’ rights
whereby a point is added for the presence of each provision. The presence of each
provision is seen as giving more power to management thus tipping the balance of
power in favor of management at the expense of shareholders. Accordingly, the
index ranges from zero to 24, with zero being the best governed and 24 being the
worst governed. The provisions can be grouped into five categories: (1) tactics for
delaying hostile bidders (Delay); (2) voting rights (Voting); (3) director/officer
protection (Protection); (4) other takeover defenses (Other); and (5) state laws
(State). A detailed description of those provisions can be found in ‘‘Appendix’’. The
sample is divided into two subsamples according to a median G-Index (10). This
division results in a subsample of 78 good governance firms, and a subsample of 80
poor governance firms. The same BHAR and CAR values used above for each
subsample are recalculated in order to perform the comparison.
The ordinary least squares regression method is then used to control for the
various factors that affect market reaction to carve-outs. For short term reaction, the
dependent variables are: BHAR -1/1, -3/3, -5/5 days, CAR -1/1, -3/3, and
-5/5 days. In addition to the G-Index, the corporate G-Index of Gompers et al.
(2003), the following independent variables used are described below.
The empirical investigations control for parent firm size at the time of equity
carve-out using the logarithm of market capitalization, Log market capitalization
(Madura and Nixon 2002). Following Allen and McConnell (1998), the use of
generated funds has been controlled for using a Payout-related dummy (vice versa,
Investment-related dummy) that is equal to one (zero) if the parent firm uses part or
all the IPO proceeds to repay an existing debt or to pay stockholders, zero (one)
otherwise. Information on the use of funds was extracted from SDC platinum. In
line with prior research, the empirical investigations control for the effect of
industry membership. A Hi-tech dummy equal to one if a hi-tech firm, zero
otherwise is added. This dummy is used to account for the fact that technology
stocks experienced unprecedented growth in the late part of the 90s (Gompers et al.
2003).
The following variables are included within the context of agency costs. CEO
Ownership, which is equal to the fraction of shares held by the CEO based on the
entire number of shares outstanding prior to the announcement day of carve-out, is
controlled for as well. The use of this variable is in accordance with Madura and
Nixon (2002) who controlled for the effect of higher management ownership on
performance following carve-outs. The higher the proportion of shares owned by
officers, the more focused those officers might become on making decisions that
enhance the performance of the parent firm. Similarly, He et al. (2009) use the same
variable to capture potential agency problems, where they argue that insider
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481
investors like CEOs are more capable monitors of firms than individual investors.
According to the entrenchment hypothesis, CEO ownership may however result in
further agency problems, thus reducing market reaction. The Large Shareholders
Ownership variable indicates the percentage of shares held by large shareholders
with more than 5 % share ownership (Vijh 2002; Allen and McConnell 1998;
Powers 2003; and Hulburt et al. 2002). The Same SIC (4-digits) dummy is also
added and is equal to one if both parent firms and subsidiaries are from the same
industry, zero otherwise. This variable is used to test whether an efficiency benefit to
carve-outs exists (Vijh 2002; Allen and McConnell 1998). Parent FCF/Total Asset
during the last year prior to carve-out announcement, indicates the firm’s cashgeneration ability and is positively related to the existence of potential agency
problems between managers and shareholders. Parent ROA measures the profitability of the parent firm while Issuer ROA measures the profitability of the equity
carve-out. The Price-to-Book ratio measures the amount of market value which is
attributable to the growth potential of the firm (He et al. 2009; Hulburt et al. 2002;
Vijh 2002; Powers 2003). Dividend Yield indicates how much a firm pays out in
dividends per share divided by the closing price per share during the day prior to the
announcement date. Dividend yield is used as a proxy of the extent of agency
problems related to free-cash flow. These variables are used in accordance with
Hulburt et al. (2002), Allen and McConnell (1998), and Powers (2003).
In terms of market conditions, a Bubble dummy, equal to one if the
announcement occurred during the bubble period 1999–2000 and zero otherwise,
is added. This variable is used to account for managers using market timing and
carrying out carve-outs during the stock bubble period, which is consistent with
Gleason et al. (2006) who used a similar variable to control for market overvaluation and timing. The stock price momentum of the parent firm is controlled for
using BHAR (-1Y), the BHAR of the parent firm during the 1 year period prior to
the announcement date of carve-out.
The testable model of short-term market reaction in hypothesis (1) can be written
as follows:
Shortterm Market Reaction ¼ a0 þ a1 x GIndex þ a2 x Log Market Capitalization
þ a3 xPayoutrelated dummy þ a4 xHitech dummy þ a5 x CEO Ownership
þ a6 xLarge Shareholders Ownership þ a7 xSame SIC ð4 digitsÞ dummy
þ a8 x Dividend Yield þ a9 xPricetoBook ratio þ a10 x Parent FCF=Total Asset
þ a11 xParent ROA þ a12 x Issuer ROA þ a13 xLog ð1 þ BHAR1YÞ
þ a14 xBubble dummy þ e1
ð1Þ
As the G-Index ranges from 0 to 24, with zero being the best governed and 24
being the worst governed, a negative relationship between G-Index and short-term
market reaction is consistent with our prediction on a positive effect of corporate
governance practices on market performance.
To test the long-term effects in hypothesis (2), another set of regressions is run
using the BHAR over a 1-, 2-, and 3-year period (BHAR 1, 2, and 3Y, respectively)
as dependent variables. The model can be written as:
123
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S. Chahine, M. J. Zeidan
Longterm Market Reaction ¼ b0 þ b1 x GIndex þ b2 xLogMarket Capitalization
þ b3 x Payoutrelated dummy þ b4 x Hitechdummy þ b5 xCEO Ownership
þ b6 x Large Shareholders Ownership þ b7 x Same SIC ð4digitsÞdummy
þ b8 xDividend Yield þ b9 x PricetoBook ratio þ b10 xParent FCF=Total Asset
þ b11 xParent ROA þ b12 xIssuer ROA þ b13 x Log ð1 þ BHAR1YÞ
þ b14 xBubble dummy þ e2
ð2Þ
Where, a negative relationship between G-Index and long-run market reaction is
consistent with our prediction on a positive effect of corporate governance practices
on market performance.
To test hypothesis (3), the dynamic changes in G-Index have been added to
variables in Eq. (2) using Improving Governance dummy. Since the Gompers, Ishii,
and Metrick corporate G-Index is not continuous and data is not available for all
years, improvement in governance relates to changes in the G-Index over a 3-year
period following the carve-out announcement date. Improving Governance dummy
is a dummy variable equal to one if the G-Index has improved by more than one unit
over a 3 year period, zero otherwise.
LongtermMarketReaction¼ c0 þ c1 xGIndex þ c2 xImprovingGovernancedummy
þ c3 xGIndexxImprovingGovernancedummy þ c4 xLogMarketCapitalization
þ c5 xPayoutrelateddummy þ c6 xHitechdummy þ c7 xCEOOwnership
þ c7 xLargeShareholdersOwnership þ c8 xSameSIC ð4digitsÞdummy
þc9 xDividendYield þ c10 xPricetoBookratio þ c11 xParentFCF=TotalAsset
þ c12 xParentROA þ c13 xIssuerROA þ c14 xLog ð1þBHAR1YÞ
þ c15 xBubbledummy þ e3
ð3Þ
Similarly, a negative relationship between long-run market reaction and the
interaction term G-Index 9 Improving Governance dummy is consistent with our prediction on a positive effect of corporate governance practices on market performance.
In further investigations, an interaction variable G-Index 9 Payout-related
dummy has been added to Eqs. (1) and (2) in order to verify the hypotheses. The
G-Index measures improvements in governance over the 3-year period after the
announcement of an equity-carve-out, as discussed previously. Payout-related
dummy is a dummy variable equal to one when parent firms use the proceeds to pay
creditors and/or shareholders, zero otherwise.
4 Empirical results
4.1 Descriptive statistics
Table 2 presents the descriptive statistics for the entire sample of 158 parent firms
from 1990 to 2006. Panel A includes statistics on market reaction around the carveout announcement date. Panel B exhibits the G-Index of parent firms around and
123
Corporate governance
483
Table 2 Descriptive statistics
Mean
Median
SD
Min
Max
Panel A—market reaction to carve-out announcement
Abnormal return (0)
0.003
0.007
0.028
-0.124
0.070
BHAR -1/1 days
0.004
0.001
0.036
-0.123
0.098
BHAR -3/3 days
-0.003
-0.007
0.044
-0.134
0.101
BHAR -5/5 days
0.000
-0.012
0.051
-0.131
0.120
CAR -1/1 days
0.006
0.002
0.036
-0.119
0.096
CAR -3/3 days
-0.002
-0.006
0.044
-0.137
0.107
CAR -5/5 days
0.000
-0.012
0.050
-0.134
0.119
Panel B—G-Index around and following carve-out announcement
G-Index
9.426
10.000
2.72
2.000
15.00
G-Index 3Y
9.031
9.000
2.93
1.000
16.000
Improving gov. dummy (0,3)
0.108
0.000
0.311
0.000
1.000
Proportion improving gov. (0,3)
0.317
Panel C—parent firm characteristics and market conditions
Market capitalization (in $ mil)
11,705
2,617
40,605
29.25
465,628
Payout-related dummy
0.335
0.000
0.47
0.000
1.000
Hi-tech dummy
0.152
0.000
0.36
0.000
1.000
0.057
0.001
0.14
0.000
0.909
11.503
11.000
6.921
0.000
25.000
CEO ownership (%)
Large shareholders ownership (%)
Same SIC (4-digits) dummy
Free-cash flow/total asset
0.399
0.000
-0.029
-0.089
0.49
0.270
0.000
1.000
-0.471
0.679
Parent ROA
0.022
0.025
0.060
-0.100
0.224
Issuer ROA
0.050
0.054
0.083
-0.255
0.277
21.250
Price-to-book ratio
3.204
2.095
3.606
0.528
Dividend yield
0.029
0.028
0.014
0.008
0.054
Bubble dummy
0.171
0.000
0.38
0.000
1.000
Table 2 presents the descriptive statistics for the entire sample of 158 parent firms from 1990 to 2006. Panel A includes
statistics on short-term market reaction of parent firms around the carve-out announcement date. Panel B exhibits the
G-Index of parent firms around and following carve-out announcement. Panel C presents the parent firm characteristics
and market conditions prior to the announcement day of carve-out. AR0 is the abnormal return of the parent firm during
the announcement day of carve-out. BHAR -1/1, -3/3, and -5/5 days are the buy-and-hold abnormal return over a
3-, 7-, and 11-day period around the announcement day of carve-out. CAR -1/1, -3/3, and -5/5 days are the
cumulative abnormal return over a 3-, 7-, and 11-day period around the announcement day of carve-out. G-Index is the
Corporate Governance Index of Gompers et al. (2003). G-Index 3Y is the corporate governance index level 3 years
following carve-out announcement. Improving Gov. dummy (0, 3) is equal to one for parent firms showing strictly more
than one unit improvement in their corporate governance index level 3 years following carve-out announcement.
Proportion improving gov. (0, 3) is equal to the proportion of parent firms showing improvements in their corporate
governance index level 3 years following carve-out announcement. Market capitalization is calculated at announcement (in $ mil). Payout-related dummy is equal to one for parent firms using the proceeds to pay creditors and/or
shareholders, zero otherwise. Hi-tech dummy is a dummy variable equal to one if a hi-tech firm, zero otherwise. CEO
Ownership is calculated as a fraction of the entire number of shares outstanding prior to the announcement day of
carve-out. Large shareholders ownership indicates the percentage of shares held by large shareholders with more than
5 % ownership. Same SIC (4-digits) dummy is a dummy variable equal to one if both parent firms and subsidiaries are
from the same industry, zero otherwise. Parent FCF/total Asset is equal to the free-cash-flow as a fraction of the total
assets of the parent firm. Parent ROA is equal to the net-income over the total assets of the parent firm, and issuer ROA
is calculated similarly for the carve-out firm. Price-to-book ratio is equal to the closing price during the day prior to the
announcement day divided by the last book value per share of the parent firm. Dividend yield is equal to the dividends
per share divided by the closing price per share during the day prior to the announcement date. Bubble dummy is equal
to one if the announcement occurs during the bubble period 1999–2000, zero otherwise
123
484
S. Chahine, M. J. Zeidan
following carve-out announcement. Panel C presents the parent firm characteristics
and market conditions prior to the announcement day of carve-out.
In line with prior research, the results show a positive market reaction around
equity carve-outs, with an average abnormal return of 0.3 % during the announcement date. Average BHAR values range from -0.3 % for the 7-day period to 0.4 %
for the 3-day period around announcements. Similar results are observed for the
CARs data.
Panel B exhibits the G-Index of parent firms around and following carve-out
announcement. The table shows an average G-Index of 9.426. This value is
consistent with the characteristics of the sample used in Gompers et al. (2003)
where mean G-Index ranged from 8.9 and 9.4 between the years 1990 and 1998.
Firms within the studied sample have a maximum G-Index of 15. This statistic
suggests that parent firms that implement carve-out strategies have similar corporate
governance to the average firm studied in Gompers et al. (2003).
Panel C presents the parent firm characteristics and market conditions prior to the
announcement day of carve-out. The table shows that one-third of parent firms use
the proceeds from carve-outs to repay debt or stockholders, whereas the remaining
firms use them for investment purposes. An average CEO holds 0.057 % of the
parent firm, and there is an average share ownership of 11.5 % held by large
shareholders holding more than 5 % of shares outstanding in the parent firms. A
significant fraction of parent firms and carve-out firms, 39.9 %, are within the same
4-digits SIC code. However, an average parent firm initiating a carve-out deal has a
negative free-cash-flow reaching -2.9 % of the total assets, but still has a positive
return on assets of 2.2 %, a price-to-book ratio of 3.2, and paying a dividend yield of
2.9 %. This is compared to an average return on assets of 5 % for the carved-out
firm. Finally, 17.1 % of studied firms announced their carve-outs during the bubble
period of 1999–2000, which suggests that parent firms are not necessarily looking to
time the market.
4.2 Short-term effects of corporate governance
Table 3 presents further descriptive statistics and compares the stock market
reaction of parent firms with good versus firms with poor governance around carveout announcements. The table divides the database in two sub-samples according to
the median G-Index (G-Index = 10). Panel A exhibits the short-term stock market
reaction using both BHARs and CARs, respectively.
These results show that firms with good governance have significantly higher
BHAR and CAR than firms with poor governance (at the 1 % level). Specifically,
the abnormal return at the announcement date is equal to 1.3 % on average in wellgoverned parent firms, and is significantly higher than the average abnormal return
of firms with poor governance (-0.6 %) (p = 1 %). More significantly, the BHAR
-5/?5 (CAR -5/?5) over an 11-day period around the announcement date is equal
to 3.1 % (3.1 %) in well-governed firms. The values are also significantly higher
than the average BHAR -5/?5 (CAR -5/?5), -3 % (-2.9 %), calculated for
firms with poor governance (p = 1 %).
123
-0.029
CAR -5/5 days
-0.005
-0.028
-0.015
-0.009
-0.026
-0.016
-0.009
0.019
0.021
0.029
3.360
0.027
Free cash flow/total asset
Parent ROA
Issuer ROA
Price-to-book ratio
Dividend yield
9.469
0.481
0.027
CEO ownership (%)
Same SIC (4-digits) dummy
0.123
Hi-tech dummy
Large shareholder ownership (%)
0.308
12,695
Payout-related dummy
Market capitalization (in $ mil)
0.027
2.130
0.038
0.029
-0.024
0.000
9.000
0.001
0.000
0.000
2,804
Panel B—parent firm characteristics at the time of carve-out announcement
-0.010
-0.025
CAR -1/1 days
CAR -3/3 days
-0.026
-0.030
BHAR -3/3 days
BHAR -5/5 days
-0.006
-0.012
Abnormal return (0)
BHAR -1/1 days
Panel A—market performance around carve-out announcement (1)
0.028
0.013
0.014
3.827
0.098
0.057
0.208
0.50
4.393
0.07
0.33
0.47
0.031
3.055
0.070
0.023
-0.076
0.312
13.643
0.088
0.182
0.363
10,638
0.031
0.037
54,298
0.021
0.022
0.031
0.021
0.021
0.038
0.035
0.037
0.038
0.035
0.029
2.090
0.058
0.022
-0.104
0.000
14.000
0.001
0.000
0.000
2,519
0.045
0.030
0.035
0.045
0.030
0.030
0.022
Median
Mean
Mean
SD
G-Index \ 10 (N = 78)
G-Index C 10 (N = 80)
Median
Good governance
Poor governance
Table 3 Parent firms with good versus poor governance: descriptive statistics
0.025
0.044
0.037
0.030
0.044
0.036
0.030
0.014
3.399
0.058
0.064
0.316
0.47
8.343
0.19
0.39
0.48
16,281
SD
0.100*
0.598
0.001***
0.838
0.219
0.029**
0.000
0.007***
0.310
0.469
0.751
0.000***
0.000***
0.000***
0.000***
0.000***
0.000***
0.000***
T difference
Corporate governance
485
123
123
0.160
0.000
0.37
0.182
0.000
Median
Mean
Mean
SD
G-Index \ 10 (N = 78)
G-Index C 10 (N = 80)
Median
Good governance
Poor governance
SD
0.39
0.724
T difference
***, **, * Significantly different at the 1, 5, and 10 % level, respectively (2-tailed test for significance)
(1) The Wilcoxon test for difference in medians shows strong significance in the difference of medians for all abnormal returns observations between both sub-samples at
the 0 % level
Table 3 exhibits the comparative analysis of good versus poor governed parent firms’ characteristics around carve-out announcements. Parent firms with good (poor)
governance are firms with a G-Index lower than (higher or equal to) 10, the median value of the G-Index within the studied sample. Panel A examines market performance
around a carve-out announcement, and Panel B shows parent firm characteristics at the time of carve-out announcement
Bubble dummy
Table 3 continued
486
S. Chahine, M. J. Zeidan
Buy - and - Hold Abnormal (100 basis)
Corporate governance
487
1.08
1.06
1.04
1.02
1
0.98
0.96
0.94
0.92
0.9
Timeline around Carve - out Announcement
All Sample
Poor Governance
Good Governance
Fig. 1 Parent firm stock price reaction around IPO carve-out announcement
Panel B examines parent firm characteristics at the time of carve-out announcement. The panel shows that firms with good governance have a higher CEO
ownership (p = 1 %), and higher large shareholders ownership (p = 1 %), and are
less likely to carve-out firms within the same industry (p = 5 %) than firms with
poor governance. This finding suggests that firms with good governance have more
involved CEOs and large shareholders, that is, have a higher alignment of interests
with shareholders, and are more likely to carve-out firms in a different industry than
firms with poor governance. Parents firms with good governance are likely to pay a
slightly higher dividend and have carve-outs with significantly higher return on
assets than those firms with poor governance.
Figure 1 displays graphically the stock market reaction for the entire sample of
parent firms, as well as for both sub-samples of firms with good governance versus
firms with poor governance around carve-out announcement dates (t0). The figure
shows consistent results with those reported in Panel A—Table 3 and indicates
significant BHAR for parent firms during the 40 days (from t - 20 till t ? 20)
surrounding carve-out announcements. Also shown is the contrasting BHAR trend
between firms with good and those with poor governance.
4.3 Long-term effects of corporate governance
Table 4 presents the descriptive statistics of the long-run market reaction following
carve-out announcements for the entire sample as well as for firms with poor and
good governance. Table 4 exhibits the results for the long-run abnormal return over
a 1-, 2-, and 3-year period prior to and following carve-out announcements using the
comparable firms defined using the propensity score approach. This evidence is
consistent with prior research where parent firms underperform their comparable
samples prior to and following carve-out announcements. The comparative analysis
shows that parent firms with good governance are likely to outperform their peer
123
488
S. Chahine, M. J. Zeidan
Table 4 G-Index and long-run performance following carve-out announcement
BHAR -3Y
Entire sample
N = 158
Poor governance
G-Index C 10 (N = 80)
Good governance
G-Index \ 10 (N = 78)
Mean
Median
SD
Mean
Median
SD
Mean
Median
SD
-0.347
0.543
-0.381
0.534
-0.316
0.554
0.576
0.615
0.008***
0.455
0.006***
0.753
0.062*
0.748
0.317
-0.463
BHAR -1Y
-0.104
BHAR 1Y
-0.075
BHAR 2Y
-0.075
-0.541
0.523
-0.211
0.548
-0.192
0.781
-0.202
-0.142
-0.249
-0.136
(0.793)
0.022
0.048
0.795
0.048
(0.003***)
-0.074
-0.276
0.760
0.008
0.603
-0.163
-0.240
-0.068
0.391
-0.214
-0.125
BHAR 3Y
-0.334
(0.001***)
-0.171
0.772
-0.316
-0.004
-0.128
T difference
(Wilcoxon text)
(0.165)
(0.863)
Table 4 includes descriptive statistics on the long-run market performance following carve-out
announcement for the entire sample as well as for both sub-samples, parent firms with poor versus good
governance. Parent firms with good (poor) governance are firms with a G-Index lower (higher or equal) to
10, the median value of the G-Index within the studied sample. BHAR -1Y, -2Y, and -3Y (BHAR ?1Y,
?2Y, and ?3Y) are the buy-and-hold abnormal return over a 1-, 2-, and 3-year period prior to (following)
carve-out announcement, respectively. Abnormal returns are calculated using comparable firms defined
based on the propensity score approach
firms in the industry during the 1- and 2-year period following carve-out
announcement (at the 1 and 10 % level, respectively).
4.4 Correlation matrix and multi-collinearities
Further descriptive statistics in Table 5 present the correlation coefficients between
studied variables. The results in this table indicate a negative correlation between
short-term market reaction to carve-out announcements and the level of the G-Index
which means a positive correlation between market reaction and the quality of
corporate governance standards. Table 5 also shows that short-term market reaction
is higher during the bubble period, however long-run performance is lower for firms
that announce equity carve-outs during the bubble period. Although not shown in
Table 5, the VIF test is overall lower than 1.83 which shows no evidence of multicollinearities among studied variables.
4.5 G-Index parent firm market reaction around carve-out announcement
Table 6 presents the ordinary-least-square regressions run for market reaction
around carve-out announcement. Models (1)–(3) include the results for the BHAR
over a 3-, 7-, and 11-day period around the announcement day of carve-out (BHAR
-1/1, -3/3, and -5/5 days, respectively). Models (4)–(6) include the regressions
run for the CAR over a 3-, 7-, and 11-day period around the announcement day of
carve-out (CAR -1/1, -3/3, and -5/5 days, respectively).
123
0.18
0.04
12. Large shareholders ownership
13. Payout-related dummy
0.10
0.21
0.12
0.63
-0.05
22. Improving gov.
dummy (3Y)
-0.03
0.03
0.15
0.08
0.05
20. BHAR (-1Y)
21. Bubble dummy
-0.08
-0.12
19. Issuer ROA
0.03
-0.03
-0.04
0.11
-0.12
0.05
0.04
0.07
0.03
-0.06
0.06
-0.04
1.00
0.68
-0.44
2
18. Parent ROA
17. Parent FCF/total asset
0.13
-0.01
16. Price-to-book ratio
15. Dividend yield
-0.11
0.13
11. CEO ownership
14. Same SIC (4 digits) dummy
0.11
-0.06
9. Market capitalization
10. Hi-tech dummy
-0.30
0.04
7. BHAR (?3Y)
8. G-Index
0.02
6. BHAR (?2Y)
0.36
4. BHAR (-5/?5 days)
-0.03
0.28
3. BHAR (-3/?3 days)
5. BHAR (?1Y)
1.00
0.42
2. BHAR (-1/?1 day)
1
1. Abnormal return (0)
Table 5 Correlation matrix
1.00
0.19
0.28
0.17
0.78
-0.01
0.06
0.11
-0.17
0.01
-0.04
-0.05
0.06
-0.15
0.06
0.05
0.06
0.02
-0.03
-0.51
3
1.00
0.14
0.26
0.22
-0.03
0.08
0.10
-0.09
0.02
-0.06
-0.11
0.07
-0.13
0.11
0.07
0.07
0.04
-0.08
-0.55
4
1.00
0.20
0.48
0.14
-0.04
0.00
-0.02
0.04
-0.06
0.05
0.06
-0.03
0.09
0.06
0.14
-0.03
0.11
-0.30
5
1.00
0.56
0.10
-0.07
0.01
-0.05
0.14
-0.02
-0.07
0.06
-0.03
0.02
0.05
0.07
-0.04
0.08
-0.23
6
1.00
0.03
-0.09
0.13
-0.04
0.20
-0.13
-0.18
0.05
0.06
0.06
0.03
0.04
-0.21
0.11
-0.10
7
1.00
0.02
0.01
0.09
-0.05
-0.16
0.25
-0.07
-0.08
-0.08
0.07
0.12
-0.04
-0.12
-0.26
8
1.00
0.00
0.04
0.02
0.03
0.19
0.28
-0.01
-0.16
0.24
0.32
-0.04
0.05
-0.10
9
-0.04
0.23
-0.05
-0.02
-0.17
-0.14
0.19
-0.12
-0.02
-0.08
0.02
-0.12
1.00
10
-0.06
-0.12
0.15
-0.06
0.05
0.00
0.13
-0.11
0.03
0.12
0.06
1.00
11
-0.01
-0.11
0.01
0.05
-0.09
0.06
-0.03
-0.08
0.06
0.05
1.00
12
0.08
0.07
0.07
0.05
-0.01
-0.08
0.00
-0.25
-0.03
1.00
13
0.03
-0.03
-0.21
0.02
0.07
-0.11
0.05
-0.05
1.00
14
-0.04
-0.06
-0.12
0.08
0.03
-0.03
-0.05
1.00
15
Corporate governance
489
123
123
-0.17
0.10
-0.03
-0.08
-0.05
18. Parent ROA
19. Issuer ROA
20. BHAR -1Y
21. Bubble dummy
22. Improving gov. dummy (0, 3Y)
0.01
0.02
0.13
-0.12
0.20
1.00
17
-0.02
0.05
0.12
-0.06
1.00
18
-0.02
-0.23
-0.10
1.00
19
-0.09
0.05
1.00
20
0.00
1.00
21
1.00
22
Pearson’s correlation coefficients were used for continuous variables, point biserial correlation coefficients were used for dichotomous variables. N = 158; correlation
coefficients [0.10 (0.13) or \-0.10 (-0.13) are significant at the 0.05 (0.01) level and above
-0.12
1.00
16
17. Parent FCF/total asset
16. Price-to-book ratio
Table 5 continued
490
S. Chahine, M. J. Zeidan
Corporate governance
491
Table 6 G-Index and the market reaction to carve-out announcement
Constant
BHAR -1/
1 days
(1)
BHAR -3/
3 days
(2)
BHAR -5/
5 days
(3)
CAR -1/
1 days
(4)
CAR -3/
3 days
(5)
CAR -5/
5 days
(6)
0.130
0.131
0.119
0.093
0.084
0.056
0.108
0.090
0.114
0.093
0.111
0.152
-0.015**
-0.017***
-0.020***
-0.010*
-0.016***
-0.011**
0.007
0.005
0.006
0.005
0.006
0.005
Log market
capitalization
-0.019*
-0.014*
-0.014*
-0.030**
-0.038**
-0.045***
0.011
0.008
0.007
0.012
0.015
0.016
Hi-tech dummy
0.056**
0.035*
0.056*
0.100*
0.113*
0.129*
0.025
0.019
0.032
0.051
0.062
0.073
0.144*
0.189**
0.142*
0.223*
0.188*
0.188
G-Index
CEO ownership
0.073
0.088
0.084
0.120
0.110
0.188
Large shareholders
ownership
2.143*
1.956*
2.208*
2.287**
2.782**
2.345*
1.133
1.100
1.222
1.062
1.287
1.248
Payout-related
dummy
0.017*
0.022**
0.024*
0.021*
0.007
0.000
0.029
0.010
0.013
0.012
0.034
0.038
Same SIC dummy
(4 digits)
-0.036
-0.029
-0.017
-0.071*
-0.125**
-0.107**
0.046
0.023
0.040
0.041
0.058
0.049
Dividend yield
1.517*
1.634**
1.652*
1.647*
2.505**
2.306*
0.880
0.755
0.903
0.933
1.178
1.204
0.000
-0.005*
-0.006*
-0.005*
-0.007**
-0.006*
0.003
0.003
0.004
0.003
0.003
0.003
Parent FCF/total
asset
-0.005**
-0.002**
-0.002*
-0.007***
-0.003**
-0.001*
0.002
0.001
0.001
0.002
0.002
0.000
Parent ROA
0.303*
0.292*
0.297*
0.263*
0.263
0.267
0.165
0.163
0.179
0.159
0.165
0.165
-0.387*
-0.289*
-0.279*
-0.479**
-0.508*
-0.483*
0.213
0.148
0.158
0.195
0.245
0.267
Log (1 ? BHAR
-1Y)
0.064***
0.074**
0.060***
0.090***
0.096***
0.106***
0.020
0.033
0.019
0.029
0.030
0.039
Bubble dummy
0.088*
0.054*
0.040*
0.045
0.024
0.030
0.047
0.030
0.022
0.047
0.058
0.064
Industry dummies
Yes
Yes
Yes
Yes
Yes
Yes
Adjusted R2
0.256
0.221
0.183
0.224
0.223
0.172
Price-to-book ratio
Issuer ROA
F statistic
4.190
3.759
3.319
3.926
3.648
3.273
Prob (F statistic)
0.000
0.000
0.000
0.000
0.000
0.001
White heteroskedasticity-consistent standard errors and Covariance. Standard errors are in italics
Table 6 includes the ordinary-least-square regressions run for market performance around carve-out
announcement. BHAR -1/1, -3/3, and -5/5 days are the buy-and-hold abnormal return over a 3-, 7-, and
11-day period around the announcement day of carve-out. CAR -1/1, -3/3, and -5/5 days are the cumulative
abnormal return over a 3, 7-, and 11-day period around the announcement day of carve-out. G-Index is the
corporate governance index of Gompers et al. (2003). All other variables are defined in Tables 2, 3 and 4
***, **, * Significantly different from zero at the 1, 5, and 10 % level, respectively
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492
S. Chahine, M. J. Zeidan
All models show evidence that is consistent with hypothesis 1. Specifically, the
abnormal return of parent firms around carve-out announcement is negatively and
significantly related to G-Index (at the 1 to the 10 % level). This correlation
suggests that firms with good governance (low G-Index) are likely to have a positive
market reaction to carve-out announcement.
Furthermore, market reaction to the news is slightly higher for hi-tech parent
firms (p = 10 %), and those using the proceeds for payout-related purposes
(p = 10 %). The market reaction is also higher for firms with higher CEO
ownership, greater involvement of large shareholders, and higher dividend yield (at
the 10 % level or more). It is also positively related to the market performance
during the year prior to carve-out announcement, and for parent firms announcing
their carve-outs during the bubble period (at the 10 % level or more).
On the contrary, the market reaction is negatively related to parent firm freecash-flow and the issuing firm return-on-asset, and the likelihood of similar SIC
between both parent and carve-out firms (at the 10 % level or more). The market
reaction to carve-out news is also lower for parent firms announcing their carve-outs
during the bubble period (p = 10 %).
4.6 G-Index and parent firm long-run market reaction following carve-out
announcement
Table 7 presents the ordinary-least square regressions run for long-run market
reaction following carve-out announcement [refer to Eq. (2)]. This regression
considers the logarithm of the long-run BHAR to control for skewness issues within
the database. Models (7)–(10) include the regressions run for the logarithm of one
plus the BHAR over a 1-, 2-, and 3-year period following carve-out announcement
(BHAR 1Y, 2Y, and 3Y, respectively). R2 values are between 0.232 and 0.292 and
those values are consistent and even higher than those values shown in prior
research in Powers (2003) and Madura and Nixon (2002).
Models (7)–(10) show that the long-run BHAR over 1-, 2-, and 3-year period is
negatively related to G-Index (at the 10 % level or more). In line with hypothesis
(2), this relation suggests that parent firms with better governance (Low G-Index)
are likely to outperform firms with poor governance during the 1-, 2-, and 3-year
period following carve-out announcement. Empirical results in Model (10) indicate
a positive and significant association between long-run market reaction and the
improving governance dummy (p = 5 %). Parent firms that are able to improve
their corporate governance standards following the carve-out announcement
outperform other firms in the studied sample. Furthermore, Model shows a negative
association between long-run market reaction and the interaction variable between
G-Index and Improving Governance dummy. Consistent with hypothesis (3), parent
firms with a better governance level at carve-out announcement and who are able to
improve their governance standards further are more likely to outperform other
parent firms in the studied sample.
In terms of control variables, Models (7)–(10) indicate that long-run
market reaction is higher in larger firms (at the 5 % level or more), those using
the proceeds for payout related purposes (p = 10 %), and lower in hi-tech firms
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Corporate governance
493
Table 7 G-Index and the long run performance of parent firms following carve-out announcement
Constant
G-Index
Log
(1 ? BHAR 1Y)
(7)
Log
(1 ? BHAR 2Y)
(8)
Log (1 ? BHAR 3Y)
(9)
(10)
-0.137*
1.051*
1.043**
0.694
0.073
0.603
0.418
0.984
-0.017*
-0.113**
-0.118***
-0.100**
0.009
0.055
0.042
0.042
Improving gov.
dummy (0, 3Y)
4.452**
G-Index 9 improving
gov. dummy (0, 3Y)
-0.506***
Log market capitalization
2.107
0.111
0.090***
0.046**
0.059**
0.053**
0.020
0.019
0.028
0.023
-0.268*
-0.412**
-0.496***
-0.342*
0.151
0.182
0.112
0.177
0.632**
0.387*
0.414**
0.529*
0.297
0.218
0.173
0.292
0.051
0.051
0.055
0.058
0.298
0.298
0.216
0.231
0.101*
0.138
0.072*
0.118**
0.056
0.156
0.039
0.054
0.011
0.011
0.046
0.183
0.203
0.179
0.197
0.515
Dividend yield
2.723*
2.870*
2.655**
2.627**
1.438
1.640
1.265
1.322
Price-to-book ratio
0.027
0.041
0.043
0.039
0.027
0.038
0.029
0.030
-0.012*
-0.025*
-0.022*
-0.025*
0.007
0.015
0.012
0.014
1.462*
1.884
1.474*
1.521**
0.755
1.217
0.752
0.763
-1.982**
-1.654*
-1.959*
-1.938*
0.853
0.930
1.042
1.061
-0.019
-0.032
-0.198
-0.074
0.097
0.065
0.124
0.095
-0.251**
-0.348*
-0.210**
-0.556**
0.105
0.189
0.087
0.238
Industry dummies
Yes
Yes
Yes
Yes
Adjusted R2
0.286
0.232
0.292
0.284
Hi-tech dummy
CEO ownership
Large shareholders ownership
Payout-related dummy
Same SIC dummy (4 digits)
Parent FCF/total asset
Parent ROA
Issuer ROA
Log (1 ? BHAR -1Y)
Bubble dummy
F statistic
3.605
3.123
3.872
3.719
Prob (F statistic)
0.000
0.000
0.000
0.000
White heteroskedasticity-consistent standard errors and Covariance. Standard errors are in Italics
Table 7 includes the ordinary-least-square regressions run for long-run market performance following carve-out
announcement. BHAR 1Y, 2Y, and 3Y are the buy-and-hold abnormal return over a 1-, 2-, and 3-year period following
carve-out announcement, respectively. G-Index is the corporate governance index of Gompers et al. (2003). Improving
governance dummy is equal to one if the G-Index has decreased over the studied period, zero otherwise. All other
variables are defined in Tables 2, 3 and 4
***, **, * Significantly different from zero at the 1, 5, and 10 % level, respectively
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494
S. Chahine, M. J. Zeidan
(at the 10 % level or more), and those announcing their equity carve-outs during the
bubble period (at the 5–10 % levels). The long-run market reaction is likely to
increase for parent firms with higher CEO ownership at the time of carve-out
announcement, and those with higher dividend yield. On the contrary, it is likely to
decrease for parent firms with greater free-cash-flow (p = 10 %), and those with
carve-out firms generating higher return-on-asset (p = 10 %).
5 Further investigations and robustness checks
5.1 Equity carve-outs and the market reaction to the use of proceeds
The use of funds obtained from carve-outs may however affect both short-term and
long-term market reaction of parent firms. Specifically, management can either pay
the surplus funds raised from executing the carve-out to bondholders and
stockholders (payout-related use of proceeds), or retain them to be invested at its
own discretion later on (investment-related use of proceeds). Management’s control
of discretionary capital can thus lead to a rise in agency costs as the surplus funds
may be used by management for purposes that would not necessarily be of benefit to
shareholders. This idea suggests that investors are likely to react more favorably to
carve-out announcements where parent firms use the proceeds to pay creditors or
shareholders rather than those where funds are retained (Allen and McConnell
1998), which is consistent with the financing hypothesis of asset sales (Lang et al.
1995). Besides reducing costs related to managerial incentives, repayment of debt
can also reduce agency costs associated with sub-optimal debt levels. The use of
proceeds to pay creditors should thus help increase firm value in the long run.
Corporate governance mechanisms, such as a high level of protection of
shareholders’ rights, may mitigate the abovementioned agency problems related
to the choice of optimal debt level, and strengthen the positive short-term market
reaction to carve-out announcements and the long-run market performance in parent
firms that use equity proceeds to pay creditors.
Table 8 presents the ordinary-least square regressions for both the short-term
market reaction and the long-term reaction over a 1-year period following carve-out
announcements. Both regressions account for the use of the proceeds resulting from
the carve-outs. In line with Allen and McConnell (1998), the results in Model (11)
show a positive and significant association between payout-related use of proceeds
and short-term market reaction around carve-out announcements (p = 10 %).
This correlation supports the idea that the market treats the surplus funds at
management’s disposal negatively in accordance with the managerial discretion
hypothesis. Also, Model (11) shows that market reaction is negatively related to the
interaction term between payout-related use of proceeds G Index (at the 10 and 5 %
levels, respectively). This relation suggests that good corporate governance
(i.e., lower G Index) positively moderates the association between payout-related
use of proceeds and market reaction around the carve-out announcement, and helps
mitigate the agency problems associated with the choice of debt level, which is
consistent with the hypotheses.
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Corporate governance
495
Table 8 G-Index and the use of
the gross proceeds
Constant
G index
Payout-related dummy
G index 9 payout-related dummy
Log market capitalization
Hi-tech dummy
CEO ownership
White heteroskedasticityconsistent standard errors and
covariance. Standard errors are
in Italics
Large shareholders ownership
Table 8 includes the ordinaryleast-square regressions run for
both the market reaction around
carve-out announcement and the
long-run market performance
following carve-out
announcement. BHAR -3/
3 days is the buy-and-hold
abnormal return over a 7-day
period around carve-out
announcement, respectively.
BHAR 1Y is the buy-and-hold
abnormal return over a 1-year
period following carve-out
announcement. G-Index is the
corporate governance index of
Gompers et al. (2003). Payoutrelated dummy is equal to one
for parent firms using the
proceeds to pay creditors and/or
shareholders, zero otherwise. All
other variables are defined in
Tables 2, 3 and 4
Same SIC dummy (4 digits)
***, **, * Significantly different
from zero at the 1, 5, and 10 %
level, respectively
Dividend yield
Price-to-book ratio
Parent FCF/total asset
Parent ROA
Issuer ROA
BHAR
-3/3 days
(11)
Log
(1 ? BHAR 1Y)
(12)
0.144
-0.132
0.093
0.081
-0.022***
-0.040*
0.007
0.060
0.012*
0.078*
0.007
0.040
-0.014**
-0.062*
0.006
0.037
-0.013*
0.089***
0.008
0.020
0.035*
-0.273*
0.018
0.157
0.181**
0.637**
0.090
0.295
1.922*
0.052
1.063
0.293
-0.029
0.012
0.023
0.193
1.648**
2.688**
0.745
1.437
-0.005*
0.029
0.003
0.028
-0.002**
-0.012*
0.001
0.007
0.304*
1.469*
0.161
0.769
-0.289*
-1.899**
0.148
0.842
Log (1 ? BHAR -1Y)
0.076**
-0.020
0.036
0.097
Bubble dummy
-0.057*
-0.253**
0.030
0.109
Industry dummies
Yes
Yes
Adjusted R2
0.230
0.278
F statistic
3.699
3.563
Prob (F statistic)
0.000
0.000
Consistent with prior results in Table 7, Model (12) shows a positive association
between payout-related dummy and the 1 year BHAR. Also, the results show
evidence of a negative association between long-run reaction and the interaction
term between G-Index and payout-related dummy. In line with the hypotheses, this
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496
S. Chahine, M. J. Zeidan
result suggests that well-governed firms that use carve-out funds to payout their
creditors have a higher long-run performance.
5.2 Robustness tests: market reaction, long-run performance
and the entrenchment index
In conducting further robustness checks, we have considered an alternative G-Index
using the Bebchuk’s et al. (2009) entrenchment index.4 Bebchuk et al. (2009) argue
that ‘‘some provisions might have little relevance, and some provisions might even
be positively correlated with firm value’’. They redefine the G-Index and construct
an entrenchment index based on six provisions: staggered boards, limits to
shareholder bylaw amendments, supermajority requirements for mergers and charter
amendments, poison pills, and golden parachutes. Bebchuk et al. (2009) argue that
while the first four provisions involve ‘‘constitutional limitations on shareholders’
voting power’’, the latter two provisions can be considered as ‘‘takeover readiness’’
provisions that may be put in place by board members (Bebchuk et al. 2009, p. 9).
Table 9 presents the regression results on the effect of the entrenchment index, E
Index, on both the short-term market reaction around carve-out announcements and
the long-run market performance following carve-out announcements.
Although not shown in Table 9, the entrenchment index is equal to 2.266 on
average for the entire sample (it is equal to 2 on median value). Moreover, the
entrenchment index is equal to 1.442 on average in the sub-sample of parent firms
with good corporate governance, which is significantly lower than the average 3.049
calculated for firms with poor governance (at the 1 % level). Models (13) and (14)
confirm our predictions. They show that both the 7-day market reaction, BHAR
-3/?3, and the BHAR 1Y are negatively related to the entrenchment index (at the 5
and 10 %, respectively). This suggests that Firm value reacts positively to carve-out
announcements by firms with lower managers’ entrenchment. A 10 % decrease in
the entrenchment index is likely to increase short-term market reaction by 0.27 %,
and long-run market performance over a 1-year period by 0.51 %. In terms of
control variables, both models indicate results that are consistent with previous
models.
6 Conclusion
This paper examines the effects of corporate governance on the short term and longterm abnormal return of parent firms executing carve-outs. The results indicate that
better governed parent firms, as defined by the G-Index, have a higher market
reaction around carve-out announcements than those with worse governance. This
result is consistent with previous research that posits that the combination of
reducing agency costs and equity carve-outs creates value for the firm and would
result in a positive market reaction (He et al. 2009; Madura and Nixon 2002).
4
We are thankful to Professor Bebchuk who gives access to the Entrenchment Index Data by Firm,
1990–2006 on his webpage (http://www.law.harvard.edu/faculty/bebchuk/data.shtml).
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Corporate governance
497
Table 9 Robustness check:
parent firm market performance
and E-index
Constant
White heteroskedasticityconsistent standard errors and
covariance. Standard errors are
in italics
Table 9 includes the ordinaryleast-square regressions run for
both the market reaction around
carve-out announcement and the
long-run market performance
following carve-out
announcement. BHAR -3/
3 days is the buy-and-hold
abnormal return over a 7-day
around carve-out announcement,
respectively. BHAR 1Y is the
buy-and-hold abnormal return
over a 1-year period following
carve-out announcement.
E-index is the entrenchment
index of Bebchuk et al. (2009).
All other variables are defined in
Tables 2, 3 and 4
***, **, * Significantly different
from zero at the 1, 5, and 10 %
level, respectively
BHAR
-3/3 days
(13)
Log
(1 ? BHAR 1Y)
(14)
0.011
-1.418**
0.080
0.534
E index
-0.027***
-0.051*
0.007
0.027
Log market capitalization
-0.010*
0.087***
0.006
0.019
Payout-related dummy
0.020**
0.064*
0.010
0.038
Hi-tech dummy
0.048**
-0.182*
0.021
0.099
CEO ownership
-0.151**
0.628**
0.063
0.276
Large shareholders ownership
-1.843*
0.052
0.970
0.296
Same SIC dummy (4 digits)
-0.026
0.013
0.023
0.216
Dividend yield
2.003*
2.376*
1.035
1.321
Price-to-book ratio
-0.005*
0.026
0.003
0.024
Parent FCF/total asset
-0.002**
-0.011*
0.001
0.006
Parent ROA
0.280*
1.597**
0.152
0.719
Issuer ROA
-0.277*
-1.883**
0.151
0.867
Log (1 ? BHAR -1Y)
0.058*
-0.017
0.031
0.130
Bubble dummy
-0.054*
-0.264***
0.030
0.096
Industry dummies
Yes
Yes
Adjusted R2
0.262
0.316
F statistic
5.134
3.851
Prob (F statistic)
0.000
0.000
Investors seem to believe that among firms that resort to carve-outs, well-governed
ones have more value.
Prior research indicates that long-term market performance is either negative or
insignificant (Chahine and Goergen 2010; Madura and Nixon 2002), suggesting that
firms are unlikely to benefit from carve-outs in the long run. However, the results of
this study provide evidence on the positive role played by corporate governance. In
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S. Chahine, M. J. Zeidan
this instance, firms with good governance outperform their peers. This finding
suggests that good corporate governance reduces agency costs and helps firms reap
the long-term benefits of carve-outs in divestiture gains. The results support prior
research that attributes the degradation in performance to agency costs from
managerial discretion that arise in the long run, leading to a reduction in the gains
initially projected around carve-out announcements (He et al. 2009; Powers 2003).
Furthermore, this study shows evidence on the positive effect of improvements in
corporate governance practices on long-term stock market reaction after carve-out
announcements. The implication is that corporate governance should be considered
a dynamic process that evolves over time, and that firms have different learning
curves, therefore they have different success rates in improving their governance
mechanisms. Firms that succeed in improving their G-Index achieve better
performance than their counterparts. In addition to that, firms that start initially
with a good G-Index and succeed in improving the rating further, outperform other
comparable firms.
The study also shows evidence on the effects of corporate governance in
mitigating agency problems (or perceived agency problems) related to the use of
proceeds. Good governance moderates market reaction around carve-out announcements positively in firms paying out creditors and shareholders. The role of good
governance extends to the use of proceeds for payout purposes in positively
affecting the long-run market reaction following carve-out announcements.
From a theoretical perspective, several propositions try to explain the reasons
companies resort to carve-outs. They range from signaling to the market the true
value of parent firms, improving efficiency, raising funds, and other miscellaneous
reasons like market timing the issuance of shares (Nanda 1991; Schipper and Smith
1986; Vijh 2002). Those various incentives are not mutually exclusive as carve-outs
may be motivated by more than one reason, and prior research is inconclusive as to
which one is more dominant (Powers 2003). While deciphering the reasons is
outside the scope of this paper, the fact that the results show that corporate
governance can alleviate the long-term degradation in performance supports the
theories that attribute the discrepancy between short-term abnormal returns and their
disappearance in the long run to agency costs. The resulting improvement from the
alleviation of agency costs implies that such costs are not only perceived in the short
run by potential investors, but that to some extent they also exist in the long run.
This indicates that for some firms with weaker corporate governance, management
is engaging in carve-outs for self-serving motives (Allen and McConnell 1998) such
as additional compensation packages for managers (He et al. 2009; Madura and
Nixon 2002; Powers 2003). Investor suspicion of such self-serving motives by
management is therefore accounted for by the market following an equity carve-out
announcement.
One limitation is that this research does not account for factors that cause
changes in corporate governance, such as changes in legislation for example. Clark
(2005) identifies four sources of policy change: the Sarbanes–Oxley Act (SOX),
changes in listing requirements, emergence of governance rating agencies, and
tougher judicial opinions. He shows that firm performance depends on the type of
reform undertaken. Another limitation is that the focus is on carve-out
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Corporate governance
499
announcements by US listed parent firms and does not take into consideration
whether differences in countries, and thus cultures and institutional frameworks,
might affect investors’ reaction to changes in corporate governance differentially.
The findings of this study highlight the importance of corporate governance
following equity carve-out announcements. Future research may extend those
findings to other corporate restructuring mechanisms such as spin-offs, and other
benefits related to improving governance.
Appendix: Corporate-governance provisions
Corporate governance provisions as defined by Gompers et al. (2003)
Antigreenmail Provisions that prevent greenmail arrangements in which a large
shareholder sells back his stock to the company, usually at a premium, in exchange
for not seeking control for a specified period of time. The exception where
antigreenmail agreements do not apply is when the same repurchase offer is made to
all shareholders or approved by a vote.
Blank Check using preferred stock to implement poison pills or prevent takeovers
by placing this stock with friendly investors. Preferred stock is stock over which the
board of directors has broad control over its voting, dividend, conversion, and other
rights.
Business Combination laws Once a shareholder’s share passes a pre-specified
threshold, a moratorium (delay or suspension of activity) is placed between the
shareholder and the company on certain kinds of transactions such as asset sales and
mergers. The moratorium ranges between 2 and 5 years depending on the state.
Bylaw and Charter Amendment Limitations Provisions that limit the shareholders’ ability to amend the governing documents of the corporation. This can be
achieved by requiring a super majority vote for amendments, completely prohibiting
shareholders from amending the bylaws, or allowing directors to amend the bylaws
without shareholders’ approval.
Control-share Cash-out laws enable shareholders to sell their stakes to a
‘‘controlling’’ shareholder at a price based on the highest price of recently acquired
shares.
Classified Board (or ‘‘staggered’’ board) is one in which the directors are placed
into different classes and serve overlapping terms. Since only part of the board can
be replaced each year, an outsider who gains control of a corporation may have to
wait a few years before being able to gain control of the board.
Compensation Plans with changes-in-control provisions—allow caching out
options or accelerating the payment of bonuses when there is a change in control.
May be detailed in the compensation agreement, or left to the discretion of the
compensation committee.
Director indemnification Contracts are contracts that indemnify, or protect,
directors from certain legal expenses and costs resulting from lawsuits that they
cause. Some firms have both ‘‘Indemnification’’ in their bylaws or charter and these
additional indemnification ‘‘Contracts’’.
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Control-share Acquisition laws (see Supermajority).
Cumulative Voting allows shareholders to concentrate their voting power by
giving them the ability to allocate votes in any manner desired. This allows minority
shareholders to elect their favored directors. Unlike other provisions, the absence of
this one leads to adding a extra point to the G-Index.
Directors’ Duties Provisions that allow directors to consider constituencies
besides shareholders, such as employees, host communities, suppliers, when
deciding on mergers. This means that directors can reject a takeover that would have
been beneficial to shareholders and still be protected legally by this provision.
Fair-Price provisions limit the range of prices a bidder can pay in two-tier offers.
They typically require a bidder to pay to all shareholders the highest price paid to
any during a specified period of time before the commencement of a tender offer,
and do not apply if the deal is approved by the board of directors or a supermajority
of the target’s shareholders.
Golden Parachutes are severance agreements that provide cash and non-cash
compensation to senior executives upon an event such as termination, demotion, or
resignation following a change in control. They do not require shareholder approval.
Limitations on director Liability are charter amendments that limit directors’
personal liability by eliminating personal liability for breaches of the duty of care,
but not for breaches of the duty of loyalty or for acts of intentional misconduct or
knowing violation of the law.
Pension Parachutes protects cash in the pension fund of a target by preventing
the acquirer from using it to finance an acquisition. Surplus funds are required to
remain the property of the pension fund and to be used for plan participants’
benefits.
Poison Pills are securities that can be used to protect against events such as
takeover bids. Typically, poison pills give the holders of the target stock the
possibility to purchase stock in the target at a steep discount, making the acquisition
unattractive. The pill can be triggered when the bid is not approved by the board of
directors.
A Secret Ballot is a voting mechanism that ensures confidential voting whereby
an independent third party or an employee sworn to secrecy is used to count proxy
votes. This helps in eliminating potential conflicts of interest for people voting on
behalf of others, and can reduce pressure by management on shareholder-employees
shareholder-partners. Like cumulative voting and unlike all others, the absence of
this provision adds a point to the scale.
Executive Severance agreements are provisions that assure high-level executives
of their positions or some compensation. However, unlike Golden or Silver
parachutes they are not contingent upon a change in control.
Silver Parachutes are similar to Golden Parachutes in that they provide severance
payments upon a change in corporate control, the difference being that a large
number of a firm’s employees are eligible for these benefits.
Special Meeting limitations are limitations that complicate the ability to call a
special meeting by increasing the level of shareholder support needed, or
eliminating the ability to call a meeting entirely. This complicates proxy fights as
bidders have to wait till regular meetings to be able to replace board members.
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Supermajority requirements for approval of mergers are charter provisions that
set voting requirements for mergers or other business combinations at a higher value
than the threshold requirements of state law. They are typically 66.7, 75, or 85 %,
and often exceed attendance at the annual meeting. In practice, these provisions are
similar to Control-Share.
Acquisition laws These laws require a majority of disinterested shareholders to
vote on whether a newly qualifying large shareholder has voting rights.
Unequal Voting rights change the voting power dynamics by limiting the voting
rights of some shareholders and expand those of others. This can take several forms.
Under time-phased voting, shareholders who have held the stock for a given period
of time are given more votes per share than recent purchasers. Another variety is the
substantial shareholder provision, which limits the voting power of shareholders
who have exceeded a certain threshold of ownership.
Limitations on action by Written Consent can be implemented by setting a
majority threshold beyond the level of state law, requiring unanimous consent, or
eliminating the right to take action all together.
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Author Biographies
Salim Chahine is currently a Professor of Finance at the Olayan School of Business and the MBA
Program Director. He holds a Ph.D. in Finance from the University of Aix-Marseille III, and two MSc in
Financial Engineering and in Banking and Finance. His research is mainly in Initial Public Offerings,
Venture Capital, Entrepreneurial Finance, Banking, and Corporate Governance. He has published in
journals such as Strategic Management Journal, Journal of Corporate Finance, Entrepreneurship: Theory
and Practice, the Journal of Business Finance and Accounting.
Mohamad Jamal Zeidan is currently an Assistant Professor and the Assistant Dean for Corporate
Programs at the Olayan School of Business (AACSB), American University of Beirut. He holds a Ph.D.
in Management and a Masters in Business Administration. His research is mainly in strategic
management and financial performance, entrepreneurship, venture capital, corporate social performance,
and corporate governance. Dr. Zeidan teaches business management, notably strategic management, at
both the executive and graduate levels.
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