Why rms issue targeted stock - New York...

*Corresponding author. Tel.: (607) 255-2349; fax: (607) 254-4590.

E-mail address: [email protected] (J. D'Souza).

Journal of Financial Economics 56 (2000) 459}483

Why "rms issue targeted stock

Julia D'Souza!,*, John Jacob"

!Johnson Graduate School of Management, Cornell University, 368 Sage Hall, Ithaca,New York 14853, USA

"College of Business, University of Colorado at Denver, USA

Received 1 August 1999

Abstract

We analyze market reaction to targeted stock issuances and investigate possiblemotives for their use. We "nd a statistically signi"cant abnormal return of 3.61% withina three-day window around the announcement of proposed targeted stock issuances,possibly attributable to greater information on targeted stock segments as well asmonitoring and motivational advantages. We "nd lower tax-loss carry forwards among"rms that issue targeted stock compared to those that spin o! segments, suggesting thattax reasons motivate targeted stock use. The return and cash #ows of targeted stocks area!ected more by their common corporate a$liation, although industry in#uences remainstrong. ( 2000 Elsevier Science S.A. All rights reserved.

JEL classixcation: G32

Keywords: Tracking stock; Diversi"cation; Corporate focus; Corporate structure;Ownership structure

1. Introduction

This paper focuses on the issuance of &targeted' stock, or stock that representsan interest in the earnings of one division of a diversi"ed "rm (also called

0304-405X/00/$ - see front matter ( 2000 Elsevier Science S.A. All rights reserved.PII: S 0 3 0 4 - 4 0 5 X ( 0 0 ) 0 0 0 4 7 - 7

tracking stock, letter stock, or alphabet stock). To date, 14 companies haveissued 37 targeted stocks that, at one time or another, have traded in publicmarkets. Although ownership of targeted stock entitles the holder to the bene"tsof the earnings stream of a particular industry segment, the segment for whichthe targeted stock is issued remains legally a part of the consolidated company.It has therefore been conjectured that managers of conglomerates use targetedstock to obtain some of the bene"ts of a spino! (e.g., reduction in the diversi"ca-tion discount, increased security analyst interest) without the attendant loss ofcorporate control.

The "nancial press and some academics have been critical of the use oftargeted stock (e.g., Reingold, 1995; Wall Street Journal, April 11, 1995, p. 7; NewYork Times, July 12, 1994, p. D1). The New York Times quotes Professor BruceGreenwald of Columbia University as saying, `It is absolutely the purest form of"nancial engineering and it yields no bene"t at alla (July 12, 1994, p. D1).Proponents, however, argue that issuing targeted stock has very real advantagesover spinning o! divisions or having a single stock for a conglomerate. BrianFinn of CS First Boston asserts, `Letter stock is not always appropriate, butgiven the right set of circumstances it's a terri"c structurea (Wall Street Journal,April 10, 1995, p. A6).

Our "rst research objective is to present empirical evidence to shed some lighton this debate. Is the issuance of targeted stock accompanied by an increase inequity value? We "nd a signi"cantly positive market reaction of 3.61% withina three-day window around announcements of proposed targeted stock issuan-ces, similar to the market reaction to spino! and equity carve-out announce-ments. The market appears to view targeted stock issuances as value-enhancing.

Our second research objective is to investigate whether issuance of targetedstock achieves its ostensible aims of obtaining an independent valuation for theindustry segments of a diversi"ed "rm and stimulating greater security analystinterest. We analyze whether the segments represented by targeted stocksoperate independently or whether their corporate a$liations cause their perfor-mance to track their "rms more than their industry groupings. We "nd that thecontemporaneous correlation between the returns of two targeted stocks of thesame "rm is, on average, signi"cantly higher than the corresponding correlationbetween independent stocks in the same industries. Also, the returns of a tar-geted stock are more highly correlated with the returns of other targeted stocksof the same "rm than with the returns of independent "rms in the same industry,even though the di!erent targeted stocks of a "rm operate in di!erent industries.The &"rm e!ect' (which is likely to arise because of shared management, services,and liabilities) appears to dominate the &industry e!ect'. However, the industrye!ect is not smaller than that exhibited by other independent "rms in the sameindustry. In fact, targeted stock segments appear to track their industries morethan independent "rms do, possibly because they are closer than independent"rms to being &pure plays' in their respective industries.

460 J. D'Souza, J. Jacob / Journal of Financial Economics 56 (2000) 459}483

Our third research question focuses on why "rms that issue targeted stock optfor this organizational structure in preference to spinning o! one or moresegments. We compare targeted stock "rms to spino! "rms along three dimen-sions: tax status, within-"rm transfers, and "nancial leverage. In contrast totargeted stock issuances, spino!s are often taxable. We "nd that signi"cantlymore spino! "rms than targeted stock "rms report tax-loss carryforwards intheir "nancial statements in the year prior to the organizational structurechange (26.22% versus none). Tax-loss carryforwards are likely to mitigate theadverse tax consequences of spino!s. Our "ndings suggest that tax-related issuesin#uence the choice between spinning o! units or issuing targeted stocks.

Additionally, issuing targeted stock enables a "rm to keep di!erent segmentsunder the same corporate umbrella and might therefore be the preferred organ-izational choice when there are signi"cant intersegment transfers. To investigatethis possibility, we compare the ratio of intersegment to total sales for targetedstock and spino! "rms in the year prior to the organizational change. We "ndno signi"cant di!erences between the two samples.

Finally, spino!s have more direct, potentially adverse consequences for bond-holder wealth than the issuance of targeted stock, since the assets of the original"rm that collateralize its debt are divided in a spino!. Bondholders have onoccasion "led suit following the announcement of a proposed spino! (e.g.,Marriott Corp.). Financial leverage could therefore be a factor in#uencing thechoice of organizational structure. However, we do not "nd signi"cant di!er-ences in either the ratio of debt to total assets or interest coverage between thetwo sets of "rms in the year prior to the organizational change.

In summary, "rms appear to issue targeted stock to achieve some of thebene"ts of a spino! without the associated adverse tax consequences and loss ofcorporate control. Investors perceive targeted stock issuances to be value-enhancing; we document signi"cantly positive stock price reactions aroundannouncements of proposed issuances of such stock. However, business seg-ments represented by di!erent targeted stocks of the same "rm do not operateindependently of one another, nor is there evidence of greater analyst followingsubsequent to the organizational change. Targeted stock issuances might never-theless represent good news from an information perspective because of thecomprehensive "nancial statements that "rms must provide for each targetedstock segment.

2. Evolution of targeted stock issuances

The earliest use of the concept of targeted stocks was General Motor'sintroduction of an independently traded stock for Electronic Data Systems, inconjunction with GM's acquisition of EDS in 1984. EDS's previous owner, RossPerot, had expressed concern that the performance of EDS managers would

J. D'Souza, J. Jacob / Journal of Financial Economics 56 (2000) 459}483 461

have little impact on undivided GM stock. The introduction of a separatetracking stock for EDS helped convince Perot to sell the "rm (although EDSwas ultimately spun o! entirely by General Motors in 1996). GM used essenti-ally the same mechanism when it bought Hughes Aircraft in 1985. It introducedan additional targeted stock (GMH) that tracked the performance of the newsubsidiary.

USX followed this lead by issuing targeted stock in 1991. USX had two majordivisions, U.S. Steel and Marathon Oil, which operated in widely di!erentindustries. USX management felt that its undivided stock was undervalued bythe market. When Carl Icahn bought 13% of USX's stock, he demanded thatthe company spin o! its steel division to enhance shareholder value. In response,the company decided to issue targeted stock for its steel and oil divisions insteadof spinning o! the steel division. The USX targeted stock issuance di!ered fromthe letter stock issued by GM in two respects. First, the targeted stocks providedfor the relative voting rights of the two classes of shareholders to be periodicallyadjusted to conform to the relative market values of the two targeted stocks.GM's letter stocks had "xed voting rights which could cause distortions if therelative market values of the stocks changed. Second, the USX targeted stocksprovided for proceeds to be paid to the shareholders of targeted groups in theevent of a disposition. Under equivalent circumstances, letter stock is exchangedfor stock of the parent company. This provision was the source of con#ictbetween GM and Class H (Hughes) shareholders when GM later wanted to sellsome of its Hughes operations to Raytheon because GM wanted Class H share-holders to forego their right to convert Class H shares into ordinary GM sharesat a 20% premium over the prevailing price.

A number of other companies have since issued targeted stock. Pittstonintroduced separate stock for its minerals and services divisions in 1993 andthen split the services stock into two targeted stocks in 1996. CMS Energyintroduced a targeted stock for its Consumer Gas subsidiary. Ralston Purinaissued a targeted stock for its Continental Baking division in 1993 before sellingthe division in 1995. U.S. West and Tele-Communications Inc. both introducedtargeted stock in 1995 (U.S. West spun o!, as MediaOne, the division represent-ed by one of its targeted stocks in 1998.) Georgia Paci"c introduced a targetedstock for its timber division in 1997, as did Circuit City for its automobile retailunit. Sprint introduced a tracking stock for its Sprint PCS unit in 1998. FletcherChallenge of New Zealand introduced a targeted stock for its forest division in1992. The company issued three further targeted stocks for its paper, building,and energy divisions in 1996.

Several other companies, including AT&T (after its merger with Tele-Com-munications Inc.), DuPont, and Quantum Corp., have announced plans fortargeted stock issuances. Zi!-Davis and Donaldson, Lufkin & Jenrette, both ofwhich have internet operations, have announced targeted stock that will tracktheir internet interests. Other companies have attempted but failed to issue


targeted stock. In 1993, RJR Nabisco's shareholders approved the issuance ofa targeted stock for the Nabisco Food business. However, the targeted stockswere never issued, possibly because the owners of this targeted stock would notbe insulated from tobacco litigation. Kmart, in 1994, tried to introduce a track-ing stock for its specialty stores but, in the face of shareholder opposition, had tosell the stores instead. In August 1995, MCI announced its intention to createtargeted stock to separate its long distance business from its other investments.MCI called o! its plan in September 1995, claiming that the timing was notright.

3. Characteristics of targeted stocks

Targeted stock is a class of a diversi"ed company's common stock linked tothe performance of a particular business unit. A company can have two or moretargeted stocks. Targeted stock does not represent direct ownership interest inthe targeted business, but rather an ownership interest in the entire company.Holders of a targeted stock are generally entitled to vote on matters pertainingto the entire company. The number of votes that a targeted stockholder isentitled to can either be "xed at the time of issue of the targeted stock or #oatwith the market value of the di!erent targeted stocks.

The issuance of targeted stock does not entail a legal division of the company.The businesses represented by the targeted stocks remain a part of the con-solidated entity and share a common board of directors. Although the "rm'sassets and liabilities are attributed to the various targeted businesses for "nan-cial reporting purposes, legal title to the assets and responsibility for theliabilities remain with the consolidated entity.

Financial statements conforming to GAAP are prepared separately for eachtargeted business. Holders of targeted stock of a division of a company receive"nancial statements for that division in addition to the "nancials for thecompany as a whole. Earnings per share and dividends are also computedseparately for each targeted group. The income reported by the targeted busi-ness is the basis for the payment of dividends. A company can pay dividends toshareholders of one targeted stock and not others. For instance, Circuit Citypaid dividends to shareholders of Circuit City Group but not to those ofCarMax Group. Dividend payout and dividend yield ratios are generallydi!erent across di!erent targeted stocks of the same "rm. For "ve of the seven"rms for which there are enough observations to compare dividend yield timeseries across targeted stocks, we "nd that these di!erences are statisticallysigni"cant at the 0.05 level or better.

The interests of the shareholders of the various targeted stocks do not alwayscoincide. This is particularly the case when there are sizable corporate costallocations or a large volume of intra-company transactions such as goods sold


or services provided by one targeted group to another. The board of directorsassumes the responsibility of ensuring that the various targeted groups transactat arm's length. Some companies that have issued targeted stock have estab-lished a separate committee of outside directors to deal with such matters.

3.1. Targeted stocks versus equity carve-outs

Issuance of targeted stock has some similarities to equity carve-outs, whichare initial public o!erings of subsidiary equity. Equity carve-outs are a source ofcash to the parent "rm through a public sale of equity that has a claim on thesubsidiary's assets alone. Usually, the parent retains a controlling interest. Thedi!erence between an equity carve-out and an issue of targeted stock is that, inthe case of targeted stock, there is no parent-subsidiary relationship. In addition,issuance of targeted stock usually entails no external "nancing, so there is nodilution of the ownership interest of the original shareholders.

3.2. Targeted stocks versus spinows

The issuance of targeted stock has some advantages over a spino! as a re-structuring mechanism. First, it is tax free, since targeted stock is regarded asa class of the undivided company's stock. A spino! can only be tax free if itsatis"es several fairly restrictive conditions. A company can also continue to "lea consolidated tax return after the issuance of targeted stock, thereby allowingone division's losses to o!set other divisions' pro"ts. The CFO of U.S. West'sMedia Group estimated that issuing targeted stock, instead of doing a spino!,was likely to save U.S. West $200 million in potential taxes over a few years(Reingold, 1995).

In addition, issuance of targeted stock has no adverse implications forbondholders because the company is still legally undivided. While stockholdersoften prefer pure plays in a single industry, bondholders are likely to prefer themore stable earnings stream of a diversi"ed "rm. Other things being equal, thecost of capital for a "rm issuing targeted stock is likely to be lower than fora "rm that spins o! a segment.

Finally, a common top management and shared corporate costs are likely toresult in greater cost e$ciencies when "rms opt for the issuance of targeted stockin preference to a spino!. Aron (1991) models the tradeo! between the poten-tially improved managerial incentives derived from a spino! and the economiesof scope that come from association with the parent "rm. The issuance oftargeted stock allows a "rm to bene"t from both these potential advantages.

There are several reasons that the use of targeted stock has not become morewidespread. First, the ownership of targeted stock does not, in general, give theholder ownership rights to the assets of the industry segment it represents.


Voting control of the entire company has to be obtained in order to gain controlof the segment's assets. For this reason, targeted stocks might not bene"t fromthe same `takeover premiuma as "rms that have been spun o!. Second, it ispossible for management to e!ect wealth transfers between di!erent sets oftargeted shareholders because of its discretion over prices for intersegmenttransfers of goods and services, interest rates for intersegment loans, and use ofthe resources of one segment for the bene"t of another. For example, BusinessWeek (February 9, 1998, p. 106) notes that the Timber Group of Georgia Paci"cis legally obligated to sell 80% of its products to the other group at a price thatmatches the average price the latter pays to other suppliers and suggests thatthis price is lower than the price that the Timber Group could get from externalcustomers.

4. Research questions and empirical results

4.1. Announcement-period ewects

Hite and Owers (1983), Miles and Rosenfeld (1983), and Schipper and Smith(1983) "nd signi"cantly positive stock price reactions to spino! announcements.If the issuance of targeted stock confers some of the bene"ts of a spino! onshareholders, the market should also react favorably to announcements ofproposed targeted stock issuances. We test this empirically using an event studymethodology. We identify the date on which news of each proposed targetedstock issuance becomes public using the Wall Street Journal index, the corre-sponding full text article, and 8-K SEC "lings by the company. We list the "rmsthat have issued targeted stock, along with the relevant dates, in Table 1. Table 1also lists companies that have announced their intention of issuing targetedstock in the future as well as those that attempted, but failed, to issue targetedstock. We extract "nancial statement information from Standard & Poor'sCompustat database, the Compustat Industry Segment Database, and fromindividual annual reports. Data on stock prices come from the Center forResearch in Security Prices (CRSP) tapes and the Wall Street Journal.

We discard six data points because the announcement of the targeted stockissuance coincides with the announcement of the acquisition of the company forwhich the targeted stock was to be issued, and a further 11 data points becauseof unavailability of data. This leaves us with a sample of 12 announcements ofproposed targeted stock issuances representing ten di!erent companies.

To ensure the robustness of our results, we use three di!erent event studymethodologies and three event windows to estimate the market reaction toannouncements of targeted stock issuances. The three windows are one, two,and three days in length, ending with the day of the announcement of theproposed targeted stock issuance in the Wall Street Journal.


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First, we use a traditional event study procedure described in Dodd et al.(1984) with a 200-day estimation period ending 15 days prior to the announce-ment of the proposed targeted stock issuance in the Wall Street Journal. Theparameters from the estimation period are then used to "nd the abnormalreturns of each "rm on each day of the event window. We "nd a cumulativeaverage abnormal return of 3.61% (t-statistic"3.89) for the three-day eventwindow, 3.67% (t-statistic"4.86) for the two-day event window, and 1.76%(t-statistic"3.29) for the one-day event window. All of these t-statistics arestatistically signi"cant at the 1% level.

Next, we use a nonparametric event study methodology described in Corrado(1989). The procedure involves ranking the magnitude of the abnormal returnfor each "rm over the estimation and event periods and testing the signi"canceof the rank of the abnormal return in the event period. The Z-statistics from thistest for the three-day, two-day, and one-day event windows are, respectively,3.08, 3.77, and 2.73, all statistically signi"cant at the 1% level.

Our third methodology uses a cross-sectional test described in Pilotte (1992)to allow for possible increases in return variances during the announcementperiod. The t-statistics from this test for abnormal stock performance during theevent period are 3.35 (signi"cant at the 1% level) for the three-day eventwindow, 4.21 (signi"cant at the 1% level) for the two-day event window, and2.42 (signi"cant at the 5% level) for the one-day window.

These results, which are consistent across methodologies and event windows,indicate a favorable market reaction to news of a planned targeted stock issuance.Zuta (1999) and Billett and Mauer (1998) also document a positive marketreaction to news of proposed targeted stock issuances. The magnitude of thecumulative average two-day abnormal stock price return (3.67%) is comparableto that documented for spino!s by Schipper and Smith (1983) of 2.84% overa two-day window. It is also comparable to the (approximately) 2% abnormalreturn reported for equity carve-outs by Schipper and Smith (1986) and Allen andMcConnell (1998). The expected potential bene"ts of a targeted stock issuancetherefore appear to be comparable in magnitude to those of spino!s and equitycarve-outs. We test whether the magnitude of the abnormal returns at theannouncement of targeted stock issuances is signi"cantly higher than those atspino! announcements (Schipper and Smith, 1983) and at equity carve-outannouncements (Schipper and Smith, 1986; Allen and McConnell, 1998) by con-structing the Bonferroni 90% joint con"dence intervals around these estimates asdescribed in Neter et al. (1985). We "nd that the con"dence interval from our studyoverlaps with those of these prior studies, implying that the abnormal returnsdocumented hereare not signi"cantly di!erent from those reported in prior studies.

4.2. Do targeted stock segments operate independently?

One of the reasons o!ered for spino!s and the issuance of targeted stock isthat the market undervalues diversi"ed "rms. A spino! remedies this de"ciency


by granting complete independence to the industry segment. Targeted stocktries to achieve some of the same e!ect by uncoupling the earnings and dividendstreams of targeted segments. We investigate whether this objective is achievedby examining whether the stock returns, earnings, cash #ows, and dividends oftargeted stocks track the industry to which the targeted segments belong orwhether they instead track the "rm with which the segments are a$liated. In anattempt to determine whether targeted stock segments track their industry, wealso compare the operational performance and valuation of segments represent-ed by targeted stock to those of a control sample comprising independentsingle-segment "rms in the same industry, The sample used for these testsrepresents all targeted stocks issued prior to 1998.

Critics of targeted stock issuance argue that targeted segments do not enjoythe operational independence that exists between a spino! "rm and its parent.Cross-dependence is likely to arise as a consequence of shared assets andliabilities, shared corporate services, and a common top management. Oneimplication of these commonalities is that the "nancial performance measures ofdi!erent targeted stocks of the same "rm could be more positively correlatedthan similar measures for independent "rms in the same industry or a spino!"rm and its parent.

On the other hand, if the common management of the "rm permits cross-subsidization across the divisions represented by the targeted stocks, there couldbe a negative correlation (or a reduction in the positive correlation) between the"nancial performance measures of these segments. Decisions that could inducesuch a negative correlation include allocations of common costs, transfer pricesfor intra-company sales, and interest rates for loans from one division toanother.

4.2.1. Correlation between xnancial performance metrics of targeted stocks andindependent xrms in the same industry

We compare the correlation between the performance of targeted stocks ofa single "rm to the corresponding correlation between the performance ofindependent "rms operating in the same industries. If targeted stocks of thesame "rm operate independently of each other, these correlations should besimilar. We examine "ve "nancial performance metrics: monthly stock returns,daily stock returns, quarterly earnings, quarterly cash #ows from operations,and quarterly dividend yields. For each targeted stock, we identify independentcompanies operating in the same four-digit SIC industry classi"cation. Whenthere are more than 15 independent "rms in the four-digit SIC code classi"ca-tion, we randomly choose 15 of these using a random number generator becausethe number of correlations to be computed increases exponentially with thenumber of "rms. For each performance metric, we compute the contempor-aneous correlation between the metric for targeted stocks of the same "rm. Themean and the median of these correlations are presented in Column 1 of Table 2.


For each metric, we then compute the average correlation between independent"rms in the same four-digit SIC classi"cation codes as each pair of targetedstocks. We "rst "nd all possible pairings between "rms in the two SIC codescorresponding to each pair of targeted stocks and then average the performancemetric correlation between all identi"ed pairs of independent "rms. Column 2 ofTable 2 presents the mean and median values of these average correlations. Iftargeted stock segments of the same "rm operate as independently as do theirindustry-matched stand-alone counterparts, we would expect to "nd no signi"-cant di!erences between correlations of targeted stocks with each other and thecorrelation of independent "rms in the targeted stocks' industries with oneanother. We use the paired nonparametric Wilcoxon signed-rank test to test fordi!erences in the computed correlations between targeted stocks of the same"rm and the corresponding average correlation between independent "rms inthe same industries.

Using both monthly and daily data, we "nd that the correlation betweenstock returns of targeted stocks of the same "rm is signi"cantly positive, as is theaverage of the corresponding correlation between pairs of independent "rms inthe same industries as the targeted stocks. For both measures, the positivecorrelation between two targeted stocks of the same "rm is signi"cantly greaterthan the correlation between their industry-matched counterparts. Targetedstocks of the same "rm do not appear to trade independently of each other.Shared top management, services, and liabilities appear to induce greaterdependence in stock returns.

The correlation between contemporaneous quarterly earnings of targetedstocks of the same "rm is not statistically di!erent from zero. In addition, thecontemporaneous correlation between the earnings of targeted stocks of thesame "rm is not statistically di!erent from the corresponding correlation for thematched independent "rms. Shared corporate a$liation does not appear toinduce dependence in the earnings of di!erent targeted stocks of the same "rm.

The contemporaneous correlation between quarterly cash #ows from opera-tions for targeted stocks of the same "rm is signi"cantly positive, as is thecorresponding correlation for their industry-matched independent "rms. Thedi!erence between the cash #ow correlation for targeted stock segments versustheir industry-matched independent counterparts is signi"cant at the 5% level(two-tailed). Cash #ows have traditionally been regarded as less subject tomanipulation than earnings. The results of this test suggest that there is greaterdependence between the cash #ows of two targeted stock segments of the same"rm than would have obtained had they operated as independent "rms.

The contemporaneous correlation between the quarterly dividend yields oftwo targeted stocks of the same company is not signi"cantly di!erent from zero,nor is it signi"cantly di!erent from the correlation between the dividend yieldsof their industry-matched "rms. The dividend streams of targeted stocks of thesame "rm, like the earnings streams, appear to be independent of one another.


Tab

le2

Cor

rela

tions

of"nan

cial

met

rics

ofta

rget

edst

ocks

The

sam

ple

incl

udes

allt

arge

ted

stoc

kissu

ance

spr

iorto

1998

.Seg

men

tsas

soci

ated

with

targ

eted

stoc

ksar

em

atch

edw

ith

indep

enden

t"rm

sin

the

sam

efo

ur-

digi

tSIC

code

.Whe

nth

ere

are

ala

rge

num

ber

of"rm

sin

the

indust

ry,1

5"rm

sar

ese

lect

edat

rand

om

tore

pre

sent

the

indus

try.

Tar

gete

dst

ock

corr

elat

ions

are

com

put

edfrom

the

date

ofissu

ance

untilD

ecem

ber

1997

or

the

date

when

the

targ

eted

stoc

kst

opp

edtr

adin

g,w

hich

ever

isea

rlie

r.C

orre

lations

forth

em

atch

edin

depen

dent"rm

sar

eco

mpu

ted

forth

esa

me

tim

epe

riod

used

forth

eas

soci

ated

targ

eted

stoc

ks.

The

tim

eper

iod

used

for

theco

mputa

tion

ofc

orr

elat

ions

ther

efore

falls

withi

nth

e19

84}19

97ra

nge

.Di!

eren

cesin

the

num

ber

ofobs

erva

tions

use

dto

com

pute

the

mea

n(m

edia

n)ac

ross"na

nci

alper

form

ance

met

rics

arise

prim

arily

bec

ause

ofm

issing

dat

aon

CO

MP

UST

AT

and

CR

SP.T

here

are

also

di!er

ence

sin

the

num

ber

ofob

serv

atio

nsbet

wee

nC

olum

ns1

and

2bec

ause

,in

som

eca

ses,

indep

ende

nt"rm

sin

the

sam

efo

ur-

dig

itSIC

code

clas

si"ca

tion

coul

dnot

be

foun

don

CR

SP

orC

OM

PU

STA

T.S

ever

al"rm

spai

dno

div

iden

dsdu

ring

thesa

mple

period,

resu

ltin

gin

alo

wer

num

berofo

bser

vations

forth

equar

terly

div

iden

dyi

eld

met

ric.

The"gu

res

pre

sent

edin

Col

um

n2

are

the

mea

ns(m

edia

ns)

ofth

eav

erag

eco

rrel

atio

nbet

wee

npai

rsofin

dep

ende

nt"rm

sin

the

sam

ein

dust

ries

asea

chpai

rof

targ

eted

stoc

ksof

a"rm

.Eac

hav

erag

eis

com

pute

dove

ra

max

imum

of2

25co

rrel

atio

ns(1

5]15

)bet

wee

npa

irsof

inde

pende

nt"rm

s.The"gu

resin

Col

um

n3

are

the

mea

ns(m

edia

ns)of

the

aver

age

corr

elat

ion

bet

wee

na

targ

eted

stock

and

indep

ende

nt"rm

sin

the

sam

ein

dust

ry.

Eac

hav

erag

eis

com

pute

dov

era

max

imum

of15

corr

elat

ions

for

each

targ

eted

stoc

k.The"gu

res

inC

olum

n4

are

the

mea

ns(m

edia

ns)ofth

eav

erag

eco

rrel

atio

nbet

wee

nin

dep

enden

t"rm

sin

the

sam

ein

dus

try

asea

chta

rget

edst

ock.E

ach

aver

age

isco

mput

edov

era

max

imum

of10

5co

rrel

atio

ns[(

15]

14)/2]

for

each

targ

eted

stock

.

Var

iable

Cont

empor

aneo

us

corr

elat

ion

bet

wee

npa

irs

ofta

rget

edst

ocks

ofth

esa

me"rm

Cont

empor

aneo

us

corr

elat

ion

bet

wee

nin

dep

enden

t"rm

sin

the

sam

ein

dust

ries

asea

chpa

irofta

rget

edst

ock

s

Cont

empor

aneo

us

corr

elat

ion

bet

wee

nea

chta

rget

edst

ock

and

indep

enden

t"rm

sin

the

sam

ein

dust

ry

Cont

empor

aneo

us

corr

elat

ion

betw

een

indep

ende

nt"rm

sin

the

sam

ein

dust

ryas

each

targ

eted

stoc

k

(1)

(2)

(3)

(4)

Mea

nN

o.of

obs.

Mea

nN

o.of

Mea

nN

o.of

Mea

nN

o.of

obs.

(med

ian)of

use

dto

(med

ian)of

obs

.use

d(m

edia

n)of

obs

.use

d(m

edia

n)

use

dto

aver

age

com

pute

aver

age

toco

mpu

teav

erag

eto

com

pute

ofav

erag

eco

mpu

teth

eco

rrel

atio

ns

the

mea

nco

rrel

atio

ns

the

mea

n(m

edia

n)

corr

elat

ions

the

mea

n(m

edia

n)

corr

elat

ions

mea

n(m

edia

n)

(med

ian)

Mon

thly

stoc

k0.

2981

,224

0.10

8123

0.18

42,3

260.

1783

28re

turn

s(0

.330

)(0

.096

)(0

.174

)(0

.141

)


Dai

lyst

ock

0.18

01,2

260.

0471

260.

0902

,327

0.06

9328

retu

rns

(0.1

73)

(0.0

49)

(0.0

87)

(0.0

62)

Quar

terly

0.05

020

0.03

820

0.08

521

0.07

028

earn

ings

(0.0

87)

(0.0

20)

(0.0

79)

(0.0

43)

Quar

terly

cash

0.54

21,2

180.

1091

180.

1642

190.

105

27#ow

sfrom

(0.5

65)

(0.0

18)

(0.1

98)

(0.0

72)

oper

atio

ns

Quar

terly

0.01

717

0.02

315

0.19

117

0.19

920

divi

dend

yiel

d(!

0.01

0)(!

0.00

1)(0

.147

)(0

.173

)

1D

i!er

ence

sin

corr

elat

ions

bet

wee

nC

olum

ns1

and

2ar

esign

i"ca

ntat

the

5%le

vel(tw

o-tai

led)

orbet

terin

the

Wilc

oxo

nsign

ed-r

ank

test

,ind

icat

ing

that

corr

elat

ions

betw

een

pai

rsof

targ

eted

stock

sof

the

sam

e"rm

are

sign

i"ca

ntly

hig

her

than

the

corr

elat

ions

bet

wee

nin

dep

enden

t"rm

sin

the

sam

ein

dust

ries

.2D

i!er

ence

sin

corr

elat

ions

betw

een

Colu

mns1

and

3ar

esign

i"ca

ntat

the

5%le

vel(

two-

taile

d)orbet

terin

the

Man

n-W

hitney

test

,indic

atin

gth

atth

eco

rrel

atio

nofa

targ

eted

stoc

kw

ith

the

other

targ

eted

stock

sof

the

sam

e"rm

issign

i"ca

ntly

hig

her

than

the

mea

nco

rrel

atio

nbet

wee

nth

eta

rget

edst

ock

and

indep

enden

t"rm

sin

the

sam

ein

dus

try.

3D

i!er

ence

sin

corr

elat

ions

bet

wee

nC

olum

ns3

and

4ar

esign

i"ca

ntat

the

5%le

vel(tw

o-tai

led)

orbet

terin

the

Wilc

oxo

nsign

ed-r

ank

test

,ind

icat

ing

that

them

ean

corr

elat

ion

betw

een

ata

rget

edst

ock

and

the

indep

enden

t"rm

sin

thein

dust

ryis

sign

i"ca

ntly

hig

herth

anth

em

ean

corr

elat

ion

bet

wee

nth

ein

dep

enden

t"rm

sth

emse

lves

.


(Several of the targeted stocks and matched "rms do not pay dividends through-out the sample period, so we cannot compute correlations in dividend yield forthese stocks.)

4.2.2. Strength of xrm inyuences relative to industry inyuencesThe results of the tests described above indicate that there are signi"cant

commonalities in some "nancial performance measures of targeted stocks ofthe same "rm, induced perhaps by a common senior management teamand shared assets and liabilities. To gain insight into the relative strengthof "rm-induced versus industry-induced commonalities, we next examinewhether a targeted stock's within-"rm correlation exceeds its correlation with itsindustry.

As in the previous set of tests, we match each targeted stock with independent"rms in the same industry. For each performance metric, we measure thecontemporaneous correlation between the performance of the targeted stockand each independent "rm in the industry and compute the average of thesecorrelations. Column 3 of Table 2 presents the mean and median values of theseaverage correlations between targeted stock segments and their industry-match-ed independent "rms. As mentioned earlier, Column 1 of Table 2 shows meanand median contemporaneous correlations between performance metrics fortargeted stocks of the same "rm. The statistical signi"cance of di!erencesbetween the within-"rm and within-industry correlations is tested using thenonparametric Mann}Whitney U-Test.

The contemporaneous correlations of the monthly stock returns, daily stockreturns, quarterly earnings, quarterly cash #ows from operations, and quarterlydividend yields of targeted stock segments with the corresponding variables forthe industry-matched independent "rms (Column 3) are all signi"cantly positive,indicating signi"cant industry e!ects for these metrics. For both the monthlyand the daily stock returns, the contemporaneous correlation between twotargeted stocks of the same "rm is signi"cantly more positive than the corre-sponding average correlation between the targeted stock and its industry-matched independent "rms. Firm-level commonalities appear to be strongerthan industry in#uences. A similar result is evidenced for quarterly cash #owsfrom operations; "rm e!ects dominate industry e!ects. For quarterly earningsand dividend yields, however, the correlations between targeted stocks andindependent industry-matched "rms are not statistically di!erent from thosebetween targeted stocks of the same "rm.

Thus, for three of the "ve measures examined (monthly stock returns, dailystock returns, and quarterly cash #ows from operations), the "rm e!ect inducedby targeted stocks operating under the same corporate umbrella dominatesindustry commonalities. For none of the measures is the industry e!ect signi"-cantly stronger than the "rm e!ect. Targeted stocks appear to track the "rmmore than the industry.


Next, we examine whether the correlation of the performance metrics of eachtargeted stock with corresponding industry measures is lower than that exhib-ited by independent "rms in the same industry. For each metric, we compute theaverage industry correlation as the mean of the corresponding correlationbetween all possible pairs of independent "rms in the industry. The mean andmedian of these average correlations for the "ve "nancial measures are present-ed in Column 4 of Table 2. We compare these correlations with those betweenthe targeted stock and independent "rms in the industry. We test for thestatistical signi"cance of di!erences between these two sets of correlations usingthe Wilcoxon signed-rank test. For both daily and monthly stock returns, we"nd that the average correlation of the targeted stock with independent "rms intheir industries is higher than the average correlation between the stock returnsof the independent "rms themselves. We conjecture that this could be a result ofa targeted stock being closer to a &pure play' in an industry than independent"rms in the same SIC classi"cation, because independent "rms could havesigni"cant involvements in other industries. There are no statistically signi"cantdi!erences between Columns 3 and 4 in Table 2 for quarterly earnings, quarterlycash #ows from operations, or quarterly dividend yields. When we test fordi!erences across all performance metrics jointly, we "nd that the correlationbetween the performance of a targeted stock and that of its industry is signi"-cantly higher than the corresponding correlation for independent "rms. There istherefore no evidence that the targeted stock structure causes the industrysegments that these targeted stocks represent to be less correlated with theirindustry than they would otherwise be. On the contrary, targeted stock seg-ments appear to track their respective industries more closely than do indepen-dent "rms.

4.2.3. Diwerences in selected xnancial ratios between targeted stock segments andstand-alone xrms in the same industries

For all years subsequent to the issuance of targeted stock, we compare ratiosthat measure operational performance (return on assets and return on equity),stock performance (market return), "nancial soundness (debt to total assets andinterest coverage), market valuation (price to earnings and market to book), anddividend policy (dividend payout and dividend yield) across the targeted stocksegments and the control sample of independent "rms in the same industries.We compare targeted stock segments to all independent single-segment "rms inthe same industry using the four-digit SIC code to de"ne industry when thereare at least "ve independent "rms within a classi"cation; if this criterion is notmet, we use the three-digit SIC code (and in a few cases the two-digit SIC code)to de"ne industry a$liation. For each industry and year, we compute themedian of each "nancial ratio for all single-segment independent "rms in thatindustry. The "rst column of Table 3 reports the median ratio di!erences acrossthe time period 1989}1997 between the targeted stock segments and indepen-


Table 3Median di!erences between selected "nancial ratios of targeted stocks relative to single segment"rms in the same industry

Industry is de"ned by four-digit SIC code. If fewer than "ve independent single industry "rms areavailable in the four-digit SIC code classi"cation, the three-digit SIC code classi"cation (or, in a fewcases, the two-digit SIC code classi"cation) is used. The number of observations for some ratios arelower because of missing data on COMPUSTAT. In addition, the number of observations for theprice-to-earnings and dividend payout ratios are lower because these ratios could not be computedwhen earnings were negative. Ratios are computed for each year, in the sample period, that data areavailable on COMPUSTAT. Reported "gures represent the median di!erence, in the stated period,between the relevant ratio for the targeted stock segments and the corresponding median ratio forindependent "rms in the same industry. Price-to-earnings is the ratio of stock price at "scal year endto primary earnings per share excluding extraordinary items. Market-to-book is the ratio of stockprice at "scal year end to book value per share of common equity. Return on equity is computed asincome before extraordinary items divided by the book value of shareholders' equity. Return onassets is computed as income before extraordinary items plus after-tax interest expense, divided bytotal assets. Debt to total assets is the ratio of long-term debt plus debt in current liabilities, to totalassets. Interest coverage is the ratio of pretax income plus interest expense, to interest expense.Market return is computed as stock price at "scal year close plus common dividends per share minusstock price at previous year's "scal year close, divided by stock price at previous year's "scal yearclose. Dividend payout is de"ned as dividends on common stock divided by income beforeextraordinary items. Dividend yield is de"ned as dividends per share of common stock divided bystock price at "scal year close.

Ratio Median di!erence over Median di!erence in1989}1997 period "scal year 1996

Price-to-earnings 0.000 0.356Market-to-book 0.111H 0.000Return on equity 0.056HHH 0.066HHReturn on assets 0.002H 0.011Debt to total assets 0.000 0.000Interest coverage 0.000 0.023Market return 0.053HH 0.100Dividend payout 0.120HHH 0.119HHHDividend yield 0.013HHH 0.010HHHNo. of observations 84 19

HSigni"cant at the 10% level using the Wilcoxon signed rank test.HHSigni"cant at the 5% level using the Wilcoxon signed rank test.HHHSigni"cant at the 1% level using the Wilcoxon signed rank test.

dent single-segment "rms in the same industry. Since each targeted stocksegment is represented in the sample in multiple years, these observations arenot strictly independent. For comparison with a sample in which the observa-tions are independent, the second column of Table 3 reports results for the year1996, the year with the highest number of observations. Each targeted stocksegment is represented once, at most, in this sample.


The most striking di!erence between targeted stock segments and theircomparison "rms is in the dividend payout and dividend yield ratios. Targetedstock segments pay out 12% more of their earnings in the form of dividends thando comparison "rms. This di!erence is signi"cant at the 1% level in both the 1996and overall samples. Similarly, the dividend yield of target stocks is 1.3% higherthan that of independent single-segment "rms in the industry. We conjecture thatthe stability that comes from being associated with a diversi"ed "rm allows these"rms to pay out a greater proportion of earnings in the form of dividends. It is alsopossible that these "rms pay higher dividends to signal to skeptical marketparticipants that their rather controversial equity structure is viable.

Although targeted stock segments appear to reinvest relatively lower propor-tions of earnings, they are not characterized by higher levels of external "nanc-ing via debt than their independent counterparts. However, ratios involvingassets or liabilities have to be interpreted with caution for targeted stocksegments. Although assets and liabilities are assigned to each targeted stocksegment for "nancial reporting purposes, the corporate entity retains legal titleto all assets and bears legal responsibility for all liabilities. The return on equityof targeted stock segments is on average signi"cantly higher than that ofsingle-segment "rms in the same industry. It should be noted, however, thathigher dividend payments reduce the book value of shareholder equity, biasingthe return on equity upward for targeted stock segments relative to theirindependent counterparts, all other factors being equal.

None of the other ratios analyzed di!er consistently between targeted stocksegments and their comparison "rms across Columns 1 and 2 of Table 3.Interestingly, the price-to- earnings ratio of targeted stock segments is notsigni"cantly lower than that of independent "rms in the same industry. Thus,there is no evidence that the earnings of targeted stock segments are undervalu-ed relative to those of their independent single-industry peers.

4.3. Targeted stock issuances and changes in analyst following

It has been suggested that conglomerate "rms are undervalued becausesecurity analysts "nd it di$cult to value "rms that cross industry lines. Forinstance, Bhushan (1989) documents that an increase in the number of businesssegments within a company is accompanied by a drop in analyst following.Analysts generally specialize in one industry, developing industry-speci"c ex-pertise. This expertise becomes less of a competitive advantage when an analystfollows diversi"ed "rms. Forecasting earnings and stock prices also becomesmore complex because forecasts for various divisions have to be aggregated. Theissuance of targeted stock has the potential to alleviate this problem by provid-ing pure plays in single industries. If analysts avoid stocks of diversi"ed "rmsbecause of the complexity introduced by conglomeration, then there should bean increase in analyst following after the issuance of targeted stock.


We test this empirically by comparing analyst followings before and after theissuance of targeted stock using the Lynch, Ryan and Jones' IBES database ofanalyst forecasts. We de"ne analyst following before the issuance of targetedstock as the number of analysts who issued at least one forecast of earnings forthe company during the year. Analyst following after a targeted stock issuance isde"ned as the number of analysts who issued earnings forecasts for at least oneof the targeted stock segments. We again exclude companies whose targetedstock was issued to facilitate mergers and acquisitions. Because of lack offorecast data availability, we are also forced to exclude instances in which thetargeted stock was issued after 1995.

Table 4 compares analyst following for the years before and after targetedstock issuances. After the issuance of targeted stock, we report (in the "rst row)the number of di!erent analysts who issue forecasts for at least one of thetargeted stock segments of the company as well as (in the following rows) thenumber of analysts who issue forecasts for each of the targeted stock segments.It is evident that there is a signi"cant overlap in the analysts who follow thetargeted stocks of a company. An analyst who follows one targeted stock ofa company also generally follows any others.

When we investigate changes in analyst following before and after theissuance of targeted stock, we "nd that both the sign test and the Wilcoxonsigned-rank test indicate no statistically signi"cant change in analyst following.In other words, the issuance of targeted stock does not appear to generate animmediate increase in analyst interest. Because all but two issuances of targetedstocks occur in the mid-1990s, however, we are not able to examine analystfollowing beyond the "rst year after the issuance. It is possible that analystfollowing increases in subsequent years. In addition, because we computeanalyst following solely from the IBES database, we do not pick up analysts whowork for brokerage houses that do not supply forecasts to IBES. This could leadto understatement of analyst following, but we do not believe that it systemati-cally biases our test.

An analyst's valuation task is likely to be facilitated by the comprehensive"nancial statements that "rms must provide for each targeted stock segment. Ifthe market assigns a lower valuation to "rms that cross industry boundariesbecause of the increased risk resulting from the paucity of information, theissuance of targeted stocks could still be viewed as good news from an informa-tion perspective, even without a change in analyst following.

4.4. Targeted stocks versus spinows

For insight into the motivations of "rms that issue targeted stock, we comparethem to a sample of "rms that undertake spino!s in the same period. Since the"rms that issue targeted stocks presumably considered and rejected the optionof spinning o! the targeted stock segment, we look for systematic di!erences


Table 4Analyst following around targeted stock issuances

Analyst following is computed from the IBES database of Lynch, Ryan and Jones. Analyst followingprior to the issuance of targeted stock is de"ned as the number of analysts who issued at least oneforecast of annual earnings for the company during that year. Analyst following after the issuance isde"ned as the number of analysts who issued at least one forecast of earnings for at least one of thetargeted stock segments. The sample consists of "rms that issued targeted stocks prior to 1996, withthe exclusion of those that announced mergers and acquisitions concurrently with the targeted stockissuance.

Company Year Analystfollowing

USX (before issue) 1990 35

USX (after issue) 1992 37Marathon group 1992 32U.S. Steel group 1992 22

USX (before issue of Delhi group) 1991 31Marathon group 1991 28U.S. Steel group 1991 25

USX (after issue of Delhi group) 1993 40Marathon group 1993 33U.S. Steel group 1993 26Delhi group 1993 6

Pittston (before issue) 1992 11

Pittston (after issue) 1994 10Services group 1994 6Minerals group 1994 5

Ralston Purina (before issue) 1992 32

Ralston Purina (after issue) 1994 21Ralston Purina group 1994 21Continental Baking group 1994 5

Fletcher Challenge (before issue) 1992 2

Fletcher Challenge (after issue) 1994 1Forest group 1994 1Ordinary group 1994 1

CMS Energy (before issue) 1994 24

CMS Energy (after issue) 1996 24Utility group 1996 24Consumers Gas group 1996 4

U.S. West (before issue) 1994 40

U.S. West (after issue) 1996 32Telecommunications group 1996 30Mediavision group 1996 21

TCI (before issue) 1994 23

TCI (after issue) 1996 22

TCI group 1996 21Liberty Media Group 1996 8


Table 5Targeted stock versus spino! "rms (In year prior to organizational change)

Ratios are computed in the year prior to the spino! or the targeted stock issuance. The sample ofspino!s consists of 64 "rms that CRSP indicated spun o! a segment in the period 1990}1997. Thesample of targeted stock comprises all "rms that issued targeted stock prior to 1998, excludingFletcher Challenge (Compustat data for this "rm in the year prior to issue are not available).Price-to-earnings is the ratio of stock price at "scal year end to primary earnings per share excludingextraordinary items. Market-to-book is the ratio of stock price at "scal year end to book value pershare of common equity. Return on equity is computed as income before extraordinary itemsdivided by the book value of shareholders' equity. Return on assets is computed as income beforeextraordinary items plus after-tax interest expense, divided by total assets. Debt to total assets is theratio of long-term debt plus debt in current liabilities, to total assets. Interest coverage is the ratio ofpretax income plus interest expense, to interest expense. Dividend payout is de"ned as dividends oncommon stock divided by income before extraordinary items. The indicator variable for theexistence of tax-loss carryforwards takes the value one if the "rm had a tax-loss carryforward in thatyear and zero otherwise. Intersegment sales to total sales is computed as the sum of reportedsegment sales minus net "rm sales, divided by net "rm sales.

Ratio Targeted stock "rms Spino! "rms Mann}Whitney test fordi!erence across the twosamples: p-valueMean Median Mean Median

Price to earnings 43.34 18.27 29.18 20.57 0.55Market to book 3.08 2.01 3.21 1.77 0.17Return on equity 0.16 0.14 0.09 0.09 0.13Return on assets 0.06 0.05 0.04 0.05 0.33Debt to total assets 0.33 0.36 0.30 0.24 0.26Interest coverage 3.79 3.23 6.55 2.54 0.65Dividend payout 0.43 0.33 0.51 0.39 0.81Indicator variable for 0.00 0.00 0.26 0.00 0.06tax-loss carryforwards

Intersegment sales to 0.89% 0.00 0.60% 0.00 0.98total sales

between "rms that issue target stock and those that undertake spino!s. Usingthe CRSP distribution code for spino!s, we identify a sample of 64 "rms thatundertake spino!s in the period 1990}1997, the period during which most of thetargeted stocks are issued. The targeted stock sample consists of all "rms thatissued targeted stocks prior to 1998 (except for Fletcher Challenge, for whichCompustat data are not available for the year prior to the organizationalchange). We then compare the "rms in the two samples along several dimen-sions in the year prior to the organizational change. Table 5 presents the resultsof these analyses.

A signi"cantly higher proportion of spino! "rms report tax-loss carryfor-wards in the notes to their "nancial statements (26% versus 0% for targetedstock "rms). Tax-loss carryforwards are likely to mitigate the adverse tax


consequences of a spino!. The "nding that "rms in the two samples di!ersigni"cantly along this dimension lends credence to the anecdotal evidence thatseveral of the "rms that issue targeted stock instead of spinning o! the segmentdo so for tax reasons.

It is also possible that "rms with a signi"cant proportion of intersegmenttransactions are more inclined to issue targeted stock rather than spinning o!a segment, in order to retain all segments under the same corporate umbrella.However, we do not "nd that the intersegment to total sales ratio of "rmsissuing targeted stocks is higher than the corresponding ratio for spino! "rms.The desire to maintain control over sources of intermediate products thus doesnot appear to be a major factor in the decision not to spino! segments.

We also investigate whether, prior to the organizational change, the "nancialleverage of spino! "rms is systematically di!erent from that of "rms that issuetargeted stock, given that the two organizational structures have di!erentimplications for bondholder risk. We do not "nd signi"cant di!erences in eitherthe debt-to-total assets or the interest coverage ratios across the two sets of "rmsin the year preceding the organizational change, nor do indicators of pro"tabil-ity or future growth prospects di!er signi"cantly across the two sets of "rms.

5. Summary and conclusions

Targeted stocks represent a single-industry segment of a diversi"ed "rm.Holders of a targeted stock are entitled to bene"ts from the stream of earnings ofthe targeted business, but the business segment remains legally a part of theparent company. Proponents of targeted stock view it as a way to mitigate thediversi"cation discount that can otherwise penalize "rms operating in multipleindustries. This paper focuses on three research questions. First, does the marketview the issuance of targeted stock as value-enhancing? Second, do targetedstock issuances serve to obtain more independent performance and valuation oftargeted segments? And third, are there systematic di!erences between "rms thatissue targeted stocks to track di!erent units and those that opt to spin o! units?

We "rst investigate whether targeted stock issuances are viewed by themarket as mere cosmetic changes or whether they are accompanied by anincrease in equity value similar to that documented for spino!s. We "nda signi"cantly positive market reaction at the time of the announcement oftargeted stock issuances. This suggests that investors expect the organizationalchange to provide information advantages, to result in better monitoring ormotivation for divisional managers, or to reduce suboptimal divisional cross-subsidization.

On the second question, we examine whether targeted stock segments of thesame "rm operate and trade independently or whether their common corporatea$liation induces dependence. We "nd that the returns of targeted stocks of the


same "rm are more positively correlated than those of industry-matched inde-pendent "rms. Targeted stocks of the same "rm do not appear to tradeindependently. We "nd that both stock returns and cash #ows from operationsof targeted stock segments seem to track their "rm more than their industry.There is no evidence of increased analyst following after targeted stock issuan-ces. However, the valuation task could be facilitated by the comprehensive"nancial statements that "rms are required to disclose for each targeted stocksegment.

Finally, we "nd that "rms that issue targeted stock are more likely to havetax-loss carryforwards that could alleviate the adverse tax consequences ofa spino!. There is no evidence that targeted stock "rms are characterized bya higher proportion of intersegment transactions, a characteristic that mightpredispose "rms to retain segments under the same corporate umbrella. Weconclude that "rms issue targeted stock in an attempt to achieve some of thebene"ts of a spino! without the adverse tax consequences and loss of corporatecontrol. The market appears to regard the issuance of targeted stock as goodnews. The increase in value could stem from the availability of more detailedinformation on each targeted stock segment as well as from the monitoring andmotivational advantages of having a stock directly linked with an industrysegment. However, targeted stocks of the same "rm do not trade independentlyof each other. Firm-level commonalities appear to dominate industry-relatede!ects.

Acknowledgements

We are indebted to A. Garcia, formerly with Lehman Brothers, for hisassistance. We also thank Ajeyo Banerjee, J.C. Bosch, Richard Cook, BethCooperman, Woody Eckard, and Naomi Soderstrom for helpful comments. Theinsightful suggestions of an anonymous referee greatly helped to improve thispaper. Financial support from the Johnson Graduate School of Managementand the College of Business at the University of Colorado at Denver is gratefullyacknowledged.

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