Underpricing, partial price adjustments, and equity carve-outs

Abstract

We examine the extent to which carve-out parent announcement and ex-date subsidiary initial market-adjusted returns reflect public information for 260 equity carve-outs and their parents for the period 1990–2012. We evaluate four hypotheses related to carve-outs and their parents: partial price adjustment, prospect theory, managerial discretionary, and leaning against the wind. To test these hypotheses we use four primary variables: the percentage of the subsidiary retained by the parent, filing range adjustments, the percentage of the offering used to retire subsidiary debt, and the CBOE Volatility Index (VIX) to predict initial returns. We show that 29 %–98 % of the variation i n market-adjusted equity carve-out returns can be predicted using public information known prior to the offer date. In addition, consistent with prospect theory, we show that the increase in share value for shares retained by parent companies (overhang) offsets the level of underpricing.