Abstract
This paper investigates how spin-offs affect capital allocation decisions in diversified firms. The sensitivity of capital expenditures to investment opportunities, representing the efficiency of capital allocation decisions, improves when firms undertake spin-offs. The improvement in the efficiency of capital allocation decisions is most pronounced immediately following the completion of spin-offs (though it attenuates thereafter) and in companies that operate in a moderate (as opposed to a high or a low) number of businesses pre-spin-off. Together, these findings uncover a novel benefit that is associated with spin-offs, an improvement in the process by which managers allocate capital in the divesting firms. These results also suggest that an important theoretical mechanism that may be driving this improvement is that spin-offs enable managers to devote more attention to the capital allocation process within their remaining businesses.
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