Target Leverage and Leverage Deviation in Corporate Spin-Offs

Abstract

This paper examines the role of target leverage and deviation from target leverage in corporate spin-offs. Using the setting of corporate spin-offs as large disinvestment projects, I examine if managers of firms follow target capital structures. I show that the changes in target leverage of spin-off parents triggered by the spin-off are not addressed by corresponding changes in actual leverage. In contrast, firms that are spun off (subsidiaries) address changes in target leverage in the years after completion through corresponding capital structure adjustments. Furthermore, I investigate which firm-specific determinants explain the leverage deviation of parents and subsidiaries at the first fiscal year end (FYE) after completion, extending the pre-vious literature by distinguishing between overleveraged and underleveraged firms. For par-ents, profitability has a positive impact on the leverage deviation. For subsidiaries, growth opportunities have a negative impact on the (absolute) leverage deviation. I also examine the impact of the parent's (subsidiaries') leverage deviation immediately before the spin-off announcement (immediately after spin-off completion) and find that firms with high (absolute) leverage deviation reduce their leverage deviation in the following years. This effect is most pronounced for overleveraged subsidiaries. Finally, I investigate the impact of the leverage deviation on announcement returns. The announcement of overleveraged parents conducting an unrelated spin-off leads to negative capital market reactions. In contrast, positive reactions are observed for parents with a high (absolute) leverage deviation when they announce the spin-off of a subsidiary which operates in an industry with high growth opportunities.