Executive Compensation and the Corporate Spin-Off Decision

Abstract

This paper investigates the effect of CEO equity incentives on corporate spin-off decisions. We find that CEOs with stronger equity incentives are more likely to engage in corporate spin-offs and the announcements of such spin-offs are positively received by the market, as evidenced by both positive short-run (announcement effect) and long-run abnormal stock returns. Furthermore, the level of incentives matters for future stock performance subsequent to the spin-off. While spin-off announcements from low incentive firms have a stronger announcement effect, long run stock performance following spin-offs from high incentive firms are significantly better. A potential explanation for such differences is that low incentive firms also have more independent boards and thus the disciplining effect of a spin-off is stronger in such firms, especially in the short run. While a stronger board may be more influential at implementing key corporate decisions (such as spin-offs), better incentive alignment leads to superior long run stock performance. Our results therefore suggest that while stronger corporate governance may serve as a substitute mechanism for managerial equity incentives in the short run, they are in fact complementary to each other in the long run.